Understanding Stock Options- How Do Stock Options Work?

Stock options are an increasingly common phrase heard around the office floor but what are they? Basically, stock options give the employee the option of purchasing shares in the company they work for at a price set by the company employer. The stock options exists in both private and public companies and they are popular for a number of reasons.

* They are a good way of retaining current employees while also attracting new employees.

* They create a feeling of ownership of the company among workers

* It is a good way for new companies to hold on to as much liquidity as possible while still paying its employees.

The price of the stock is usually set by the current market price of the stock when the worker is given the option of purchasing stocks. Stocks are usually held over a medium to long time period so the hope is that during this time period the value of the stock will increase thus enabling the stock holder to sell the stock at a later time period for a profit. This is a good supplement to the employee's salary as well as motivating the employee to work harder in order to improve company production and increased stock value.

The best way of understanding how this works is to use an example. Assume that a fictional company, say, the ALBA corporation gives its workers the option of purchasing 50 shares of stock in the company for $7 a share, and then sell the shares at a later date specified in the contract. This option can be exercised by the worker starting from the 15th June 2002. Suppose that on the 15th of June the value of the shares is actually at $10 a share.

This leaves the employee with a number of options.

* The first option for the employee is to purchase the stock at $5 a share and then sell the shares on as soon as the specified time period in the contract is up at $10 a share. This leave the employee with a profit of $3 per share or $150 total profit on the 50 shares.

* Another option is to sell some of the shares after the specified time period and keep some to sell at a later date for potentially higher profits.

* The third and final option is to purchase the stock at the discounted price and hold on the it all in the hope of high future profit.