Stock Options

When investing in stocks and equities, some people are given the chance to purchase stock options, which are the right to purchase or sell a specific amount of shares in a company for a specific price and for a defined time period. The price is generally the stock's market price at the time that the option is granted. Options are issued from one investor to another through options brokers. The option to sell a stock is a "put" and the option to buy a stock is a "call."

You can make money from stock options if you exercise your stock options and purchase the stock at a price that is lower than the amount it is being sold for at the time you buy it. Conversely, it's not hard to see how stock options can also become a worthless investment.

Stock options are in an investment vehicle category known as derivatives, which is where you will find a more detailed discussion if you are interested in additional information. For most investors, unless their mutual funds participate in stock options, involvement with stock options is primarily due to employee benefit plans.

Many companies offer stock options to their employees as part of an employee benefit package. Often stock options are part of a company's retirement plan. In addition, some smaller companies or startups offer stock options as a way to attract employees when they don't have the capital to compete with salaries and other benefits. Not only can they attract top talent by offering the options, but they also know that their employees are especially affected by the success or failure of the company.

Financial Calculators Many companies issue annual stock option grants to their employees. Receiving a stream of stock options over a period of years can be an incredible benefit. Use this Annual Stock Option Grants Calculator to help you project how much a series of annual stock option grants could be worth to you. Even after a few years of moderate growth, stock options can produce a handsome return. Use this Stock Option Calculator to help you determine the value of your stock options for the next one to twenty-five years.

The danger of stock options. If you think you can make a huge profit from company stock options, you are right. However, in the world of investments, stock options are most definitely closer to gambling than a safe investment. All you have to do is take a look at the recent rash of news stories and the fate that befell many stock option holders who were "rich" one day and were left holding worthless options a short time later when their companies didn't perform as well as expected or went bankrupt.

Because predictions about a company's success or failure are not failsafe, are some stock options a safer investment than others? The main factor that makes some stock options less of a risk than others is if the company's stock is publicly traded. Stock options from a private company usually contain transfer restrictions that can affect the stock's worth. It's simply much easier to exercise stock options if a corporation's stock is traded publicly.

Employee stock-based programs are worth more if transfer restrictions, such as those normally accompanying private company stock, are not placed on the stock. Therefore, publicly traded stock can also make a business more attractive to prospective and existing employees if stock option and other stock compensation plans are offered. This, in turn, can have a positive affect on a company's success because it can draw desirable employees that believe in the company and are vested in its success. Stock options in a successful company can be a powerful investment, particularly if the options are issued over a number of years.

Tax implications. You should also be aware that exercising stock options might result in unpleasant income tax results in the form of making you subject to the alternative minimum tax. In addition there has been a real push to subject employee stock options to payroll tax. This issue is dead right now, but it is a possibility in the future.

Diversification. The best advice to hold fast to when it comes to stock options can be summed up in one word: diversify. Never put all your investment eggs in one basket if that investment is in the company you work for! While diversification is an important overall investment strategy, when it comes to investing in the company they work for, a large number of people ignore this advice.

Warning We don't want to belabor the point, but you should resist the urge to make your employer the only thing you invest even if you are super-confident that the sky is the limit when it comes to your company's success. You may be thinking that fiascos like the recent corporate scandals are the extreme and you're not worried. We concede that most companies doing well one year are not going to be in ruins in the next. However, for every nightmare investor story that you have read or know of, there are many others from other companies where employees invested so heavily or only in their employer's stock, only to suffer the consequences of missing out on other investment opportunities that would have been more successful in the long run. Moreover, an employee who invests heavily in his or her employer runs a second risk. If the company runs into difficulty, not only might the investment become worthless, but also the employee might lose his or her regular compensation if the company downsizes its workforce or closes altogether.