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here is the third post needed to finish the responses. thank you so much
Nadeem classmate dq
This paper will discuss employee stock options. It will look at what these stock options are and their benefits to employees as well as employers. Finally, it will discuss the options that employees have in exercising their stock options.
In previous weeks we have looked at different types of investments. In week four we discussed bond investments and risk along with other topics. We learned about how bonds worked. A majority of bonds are more of a lower risk low reward type of investment. Many of them will yield only a little bit more than a savings account. The price of inflation counters this as well. After this we discussed stocks. Stocks are more of a high risk high reward type of investment. They fluctuate more with the economy. A person can gain and lose a lot of money and there is a lot of risk involved with this. I had my bad experience with stocks which I discussed last week and it cost me a lot of money. I don’t know if I will ever look at stocks the same. They are a little bit like gambling. This week we will take a more in depth look at stocks. There are a variety of ways that a person can play the stock market. I would like to take a look at employee stock options in more detail.
First, it is important to look at what a stock option is. “Stock options from your employer give you the right to buy a specific number of shares of your company’s stock during a time and at a price that your employer specifies” (How do stock options work?, 2013). Public and private companies give their employees stock options. There are reasons for giving employees these options. First it makes the employers happy. It can attract workers and keep them at a company. The workers will feel like they are owners or partners. This option is also particularly a good idea for hiring skilled workers as it gives compensation that is beyond salary. Startup companies can hold on to a lot of cash this way as well (How do stock options work?, 2013). The company needs to explain the stock options to their employees. They need to lay out the timeline. They must “explain how many years the employee has to exercise their option before they expire” (Harris, 2012). Secondly, they need to explain the vesting options and scenarios. This lets employees know that their benefits will disappear when they leave the company. Usually, there is a 90 day window for an ex-employee to exercise their vested options. It is important to let them know this because you don’t want an ex-employee to bad mouth your company after they leave (Harris, 2012). Thirdly, it is important to clarify the tax that will need to be paid if an employee exercises their option. The IRS will get a large amount of this money. Your state department may get some as well. Employers need to know that this will happen so they are not surprised at the time they decide to exercise their stock options (Harris, 2012). Finally, employers must preach the merits of diversification. It is a bad idea for anyone to have all their money in one stock. An employer must tell their employees about this even though it is not in their best interest. If they find this difficult they should hire a third party to do it for them. These are very important rules that employers should follow.
What are the benefits of stock options? Employees usually get the stocks at a discounted rate which is usually at the stocks market price. An example of this is if a company sells 100 shares of stock to an employee at $10 per share. There will be a date that this employee can exercise his option for the stock. Let’s say this date is November 1st, 2013. After this date the stock may be worth $20 a share. The employee has three options. He can sell all of his shares and make a profit of $1000. He can sell some of the shares and use the rest of the money to purchase more shares. The third option would be to change all the options to stock and buy it at the discounted rate with the idea of selling later hoping that the price will go up even more (How do stock options work?, 2013).
When should an employee exercise their stock options? There are some things that an employer must know before they decide to exercise them. The first thing an employer needs to do is to know if they can exercise them. As explained previously, employers usually have a period of time that they can’t exercise their stock options which is usually 3-5 years (Taulli, 2012). This encourages employees to stay at a company longer than they would have previously wanted. The next thing an employer must know is when their options will expire. There are expiration dates on these stocks just like there are vest dates. An employer must make sure his stock options haven’t expired. An employer will usually let their employees know about this date ahead of time (Taulli, 2012). An employee must think about what else they would do with their money. Some people have other expenses like credit card debt that needs to be paid off. The high interest rates on these cards make it a good idea to pay them off rather than make a small amount in the stock. Also, an employer can use the money for a possible emergency that may pop up in the near future (Taulli, 2012). Another very interesting thing an employer must think about is what tax bracket they fall into. If they fall into a 25% bracket but will fall into the 15% bracket in a year it is a good idea to wait a year to exercise their stock options. This will save them a lot of money in taxes (Taulli, 2012). Employee stock options are very interesting and are a good way to keep employers in a company for a long period of time.
References
Harris, B. (2012, August 23). How to Explain Stock Options to Employees . Retrieved August 15, 2013, from inc.com: http://www.inc.com/bill-harris
/how-to-explain-stock-options-to-employees.html
How do stock options work? (2013). Retrieved August 15, 2013, from money.howstuffworks.com: http://money.howstuffworks.com/personal-
finance/financial-planning/stock-options.htm
Taulli, T. (2012, March 13). When Should You Exercise Your
Employee Stock Options
? Retrieved August 16, 2013, from forbes.com:
http://www.forbes.com/sites/financialfinesse/2012/03/13/when-should-you-exercise-your-options/
Noelle dQ resonse
Employee stock option is when a company offers its own stocks for purchase by its employees. Employee stock options offer an opportunity for employees to feel as though they have ownership in their workplace. In addition, it offers an incentive and a compensation option for the employer.
Employee Stock Options
Stock is ownership in a company. Companies offer employees the opportunity to purchase ownership into the company through stock options. The amounts that can be purchased, price and when they can be purchased is determined by the company (Gauna, 2013). If the purchase price is lower than the market price, this offers a great opportunity for employees and a great way to recruit and retain good employees. In addition, offering stock option is a great reward system and motivator for employers and employees. Employees have ownership into the company and therefore are more compelled to perform better. In addition, stock options can be used as a form of compensation for skilled employees (Gauna, 2013).
Generally stock options are available to employees at a discounted price (Gauna, 2013). The ideal goal and scenario is that the stock will be purchased by employees at a discounted rate in hopes that the stock price will rise in the future, thus the employee can sell the stock and gain a profit. The negative aspect is if the stocks value drops and/or the company fails.
Vesting Period
The vesting period is the time period when employees are allowed to purchase stocks. (Gauna, 2013) Typically the vesting period is several years, allowing employees to purchase a limited number of stocks per year. Some companies require an employee to work for a number of years before a stock option is offered to them.
Most stock options have a vesting period of 10 years (Money CNN, n.d.). This is the maximum amount of time which shares can be purchased. Some employee stock options program allow for all shares to be vested within a year, however generally the vesting period is staggered or phased. Each vesting period is unique to the individual company (Money CNN, nd.).
Risk
Investing in an employee stock option comes with some risk. It is recommended that employees should not purchase an overabundance of stocks. It is also important to be aware of deadlines and current stock prices. Being knowledgeable and aware of opportunities or pitfalls will allow for successful purchases with optimum results.
Common Types
Nonqualified Stock Option
There are two common types of employee stock options. The first one is nonqualified stock option. Nonqualified plans can be issued at a discount (Gauna, 2013). Nonqualified stocks do not require taxes to be paid when the stocks are issued (Money CNN, n.d.). In addition nonqualified stocks are transferable if allowed by the employer. Therefore, the stocks could be transferred to children or even a charity.
Incentive Stock Options
The second type is qualified or “incentive” stock options (Money CNN, n.d.). These are also referred to as ISOs. Incentive Stock Options qualify for special tax regulations. In some cases, gains may be taxed at a capital gains rate, which is lower than ordinary income tax rates. Usually in order for the stock to qualify for a lower income tax rate, the stock must be held for a period of time. The income tax on the incentive stocks are due when the stocks are sold. ISOs give no tax advantage to the employee that is investing (Money CNN, n.d.). Incentive stock options are usually more beneficial if offered to the higher pay grades of a business. Higher paid employees generally have the cash to purchase the stocks and can hold onto the stocks for a longer holding period.
Exercising Stock Options
Cash exercise
The cash exercise option is pretty basic. You give your employer the money for the stocks and in return you get the stock certificates in return.
Stock Swaps
Some employers allow for company stocks to be traded. In a stock swap instead of paying cash, shares of company stock are traded to acquire options stock (Money CNN, n.d.). One advantage of a stock swap is that it limits the amount of company stock that is held.
Cashless exercises
In the cashless exercise option, the investor borrows money from the stockbroker to obtain the stock options (Money CNN, n.d.). As the money is borrowed, shares of the stock are being sold to earn enough money to cover the cost of the stocks that were purchased. Any leftover or balance is paid to the stockholder in cash or in stocks.
Timing of Exercise
It is generally assumed that one should hold onto stock options until they are near expiration. This will allow for the maximum amount of appreciation and will maximize the amount of gains. Based on a market study noted in CNN magazine (n.d.), it was found that the “the typical employee cashed out of options within six months of becoming eligible to do so, thereby sacrificing an estimated $1 in future vale for every $2 realized. “
There are reasons to cash in stocks early (Money CNN, n.d.). The first reason is if there is reason to believe that the future success of the company could be questionable. The second reason is if too many stocks have been purchased. The third reason for cashing in stocks early is that if all the stocks are cashed in at one time, them it will fall into a higher tax bracket and thus selling a small portion of stocks at a time will eleviate this problem.
It is easy to estimate the value of your stock. In order to estimate the value, one can calculate how much you would pocket if you sold the shares. However, the cost of taxes must be included in the sale and thus will reduce the amount of profit earned.
Conclusion
Employee stock options are a great way for employees to invest in their employer. It allows for an incentive and an additional compensation option. Stock options offer the employees the ability to participate in a form of employee appreciation that is equity based without having any investment of upfront money (Cannon & Kessel, 2013). As with any investing it is important to remember timelines and be aware of the market. All stocks and investments carry a risk and employee stock options are not exempt from this risk.
References:
Cannon, J. & Kessel, M., (2013, August). Stock options and beyond. Nature Biotechnology. Volume 31. Number 8. Pages 676-680.
Gauna, R., (2013, March 22). Investing how do employee stock options work? Retrieved from
http://cahsmoneylife.com/employee-company-stock-options/
.
Money 101 Employee stock options. (n.d.) CNN Money. Retrieved from
http://money.cnn.com/magazines/moneymag/money101/lesson10/index4.htm
.
