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When you join a new company or renegotiate your compensation at your existing job, an employer may offer you employee stock options. These are offered as an incentive to join a company — or as a different type of compensation outside your salary — because they give you the ability to buy the company's stock at a specified price.

These stock options can be even more valuable than the number on your paycheck, depending on the future performance and value of the company. If you have access to stock options, here's what to know and consider before accepting a compensation package that includes them.

What Are Employee Stock Options?

Before making financial decisions about assets, make sure you understand how they work.

Employee stock options are a type of call option on company stock. Call options give you the right to buy a specific quantity of the stock at a particular time, for a particular price. When you buy the stock, you "exercise" your option. The time to buy is the exercise period which will come with an expiration date. Most exercise periods last about 10 years.

You're never obligated to exercise your right to buy stock. You can choose to hang on to your stock options and you can sell them at any time.

Understanding Who Benefits

Companies issue stock options for a few reasons. For one, it's a way to provide compensation to you, the employee, without disrupting the company's cash flow.

Two, stock options offer incentives to employees to behave in ways that help the company's value rise. Who wouldn't want to see the company perform well and succeed if you have the ability to sell your shares for a profit?

That's not to say the company gets all of the benefits. You do, too! The stocks you can buy are offered at a certain price, called the grant price. This is usually the market price of the stock at the time your options are issued.

When you get the option to buy more, you can purchase the stock at the grant price. If the company increases in value, that allows you to buy company stock for a lower price than what you can sell it for. And that means you can make a profit.

When to Consider Accepting and Using Stock Options

Of course, there's no guarantee that the company will increase in value. If you don't believe the business will perform better over time, you might want to decline options and negotiate other benefits for your compensation package instead.

However, if you believe in the company and see a potential for future growth, consider accepting stock options offered to you.

Understand that if the company offers you non-qualified stock options (NQs) or incentive stock options (ISOs), each operates under a different set of tax rules, which can impact how you exercise them. Your employer should provide you with information on which type of option you can receive and the rules that apply to that type.

You need a plan for how you'll exercise your options, but with NQs or ISOs you probably don't want to sell right away. If you believe the company will increase in value, hang on to your options and consider buying more stock during the period you are allowed to do so.

Waiting to sell allows the company to increase in value which means that when you do go to sell, you can do so at a profit (since the grant price was set in the past when the company was worth less).

Of course, as with all investments, this comes with risks. Know how much risk and volatility you can handle. Consider talking to a financial planner who can help you strategically manage and exercise your stock options in a way that provides you with the biggest benefit.

Disclosures

This information and recommendations contained herein is compiled from sources deemed reliable, but is not represented to be accurate or complete. In providing this information, neither KeyBank nor its affiliates are acting as your agent or is offering any tax, accounting, or legal advice.

By selecting any external link on www.Key.com, you will leave the KeyBank website and jump to an unaffiliated third party website that may offer a different privacy policy and level of security. The third party is responsible for website content and system availability. KeyBank does not offer, endorse, recommend, or guarantee any product or service available on that entity's website.

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