The Life Cycle of Employee Stock Options: From Grant to Exercise

Employee stock options are a popular form of compensation that many companies use to incentivize their employees. They offer employees the opportunity to purchase company stock at a discounted price, which can lead to significant financial gains if the company performs well. However, understanding the life cycle of employee stock options can be confusing, especially for those new to the concept. In this article, we will outline the life cycle of employee stock options from grant to exercise.

Granting the Stock Options

The first step in the life cycle of employee stock options is granting the options to the employee. Stock options are typically granted as part of an employee’s overall compensation package, and the grant will specify the number of options, the vesting schedule, and the exercise price. The exercise price is the price at which the employee can purchase the stock, and it is either set at the current market price or at a discounted price.

Vesting of the Stock Options

Once the options are granted, they typically vest over a specified period of time, known as the vesting schedule. Vesting means that the employee has earned the right to exercise the options and purchase the stock. For example, if an employee is granted 1,000 stock options that vest over four years with a one-year cliff, they would not be able to exercise any of the options until they have been with the company for one year. After the one-year cliff, the employee would be able to exercise 25% of the options, or 250 shares. The remainder of the options would vest incrementally over the next three years.

Exercising the Stock Options

When an employee exercises their stock options, they purchase the stock at the exercise price specified in the grant. If the current market price of the stock is higher than the exercise price, the employee can sell the stock for a profit. If the current market price is lower than the exercise price, the employee can hold onto the stock or sell it at a loss. It is important to note that exercising stock options can have tax implications, which can vary depending on the type of options granted, the length of time they were held, and the employee’s tax bracket.

Selling the Stock

Once an employee has exercised their stock options and purchased the stock, they have the option to hold onto the stock or sell it. If the company’s stock price has increased significantly since the options were granted, the employee can sell the stock for a profit. However, if the company’s stock price has decreased, the employee may choose to hold onto the stock in the hopes that it will increase in value in the future. It is important to note that selling the stock can also have tax implications, which can vary depending on the length of time the stock was held and the employee’s tax bracket.

Conclusion

In summary, the life cycle of employee stock options starts with the granting of the options and the vesting schedule. Once the options have vested, the employee can exercise them and purchase the stock at the exercise price. Finally, the employee can choose to hold onto the stock or sell it, which can have tax implications. Understanding the life cycle of employee stock options is important for employees who have been granted options as part of their compensation package, as it can help them make informed decisions about when to exercise their options and sell the stock.