Exercise of Stock Options

The Benefits and Rights of Exercise of Stock Options

When Can You Exercise Stock Options?

If you are working for a listed company, you may be offered an Employee Stock Option Plan (ESOP) as your salary package increases. You can exercise the stock options at a later stage. In simple terms, the exercise of stock options is buying your company's stock at a lower strike price. The benefit is that the strike price is much lower than market price. As a result, when you choose to sell the shares, you may earn a lot more.

There are two main areas that can be taken into consideration to exercise the stock options. The first would be exchange traded options and the second would be employee stock options.

What are exchange traded options?

When you have an exchange traded option or ETO contract, you have the right but not the obligation to buy or sell the stocks. It works on the principle of a set price or strike price. The right continues up until an expiration date. You can exercise the stock options with either call or put options. If you're holding call options, you are buying the financial product at an agreed strike price while with put options you are selling it the same way.

Since the expiry date is fixed for ETO contracts, you have to ensure that your exercise of stock options is by the expiration date of the contract. Many brokers will do this automatically for you, if the contract has intrinsic value. However, exercising the options may not always be the best alternative, as you may not wish to own the underlying shares, only profit from the increased value of the options themselves.

The main benefit of an ETO contract is that the buying or selling price is locked. So, if the market is falling, you are able to liquidate your investments. If the market is rising, then you can hedge your investments and later square it off at a higher price.

What are Employee Stock Options?

Companies offer Employee Stock Option Plans (ESOPs) to their employees as part of rewards and recognition. As your salary bracket increases, the company will give you their shares at lower strike prices. You can exercise the stock option at a higher rate when the stock price of your company’s share increases. Many companies will not allow the options to be exercised until some time has passed, as an incentive for their employees with remain with them.

This is beneficial as it has a lock-in period after which you can exercise the stock options. In addition, when you own shares of your company, it can give you a greater sense of ownership and involvement. As a result, you will work harder at ensuring that the company performs better.

Another advantage is that if you are acquiring ESOPS instead of salary income, it means you have more control over your tax obligations.

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