Standardized options vs employee stock options – Option Trading FAQ

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Standardized options vs employee stock options

Q: What are the differences between standardized options and employee stock options?

A: There are quite a few differences between these two types of stock options. Firstly, the terms of employee stock options are not fixed while exchange traded options have standardized terms, with each contract usually representing 100 shares of the underlying stock. Secondly, employee stock options are not traded on exchanges whereas standardized options are traded on many exchanges in the United States. Finally, employee stock options generally are not transferable while standardized options are interchangeable and can be freely traded within the trading hours on any exchange that lists them.

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Options Trading vs. Employee Stock Options – What’s the Difference?

Employee stock options have made employees at some companies instant millionaires. Companies such as Apple (AAPL), Microsoft (MSFT), and many other high tech firms have kept a good executive staff and a growing company thanks to awarding employees with participation in the ownership of the firm.

The main difference between options trading and employee stock options is the fact that options trading involves buying and selling options as a speculative endeavor, while employee stock options are generally used as a form of compensation that a company offers employees as an incentive.

Another major difference between the two is that employee stock options have no formal exchange listing and can only be exercised within the company on the stated terms that the company has provided the options under.

These terms include the price at which the employee has the option to buy the stock and how much stock the employee can purchase.

Listed Stock Options

Listed stock options are typically highly regulated and very liquid derivative financial products with values linked to the price of the underlying stock, as well as other factors like the stock’s expected volatility.

This type of option trades on an exchange and can usually be exercised at the strike price by the buyer at any time during the life of the option. The buyer can also choose whether the option is an option to buy the stock, a call option, or to sell the stock, a put option.

Employee Stock Options

On the other hand, an employee stock option is typically issued by a company to its qualified staff as a bonus and involves the firm granting the employee an option for them to buy or call a specific amount of the company’s stock at a specific price. The stock can be the company’s common stock or an issue of restricted stock set aside for this specific purpose.

The company sets the amount of shares that can be bought using the option, the strike or exercise price and an expiration date for the option. Some employee stock options have no expiration date and can be redeemed by the employee at any time.

This gives the employee an incentive to make the company more successful, since the price of the company’s stock will generally rise if the company does well. Employee stock options make up an important part of many executives’ employment contracts, although companies can also extend employee stock option plans to their other staff members.

How to Trade Listed Stock Options Against Employee Stock Options

If the employee works for a large corporation that has its stock and options listed on major exchanges, then they may be able to sell listed options or stock against their employee stock call options that act as a hedge. An exception would be if the stock obtained from the exercise of an employee option is restricted so that the employee cannot to use it to cover a short position in the company’s common stock.

Also, before trading against their employee stock options, they need to be aware that selling naked options in an equity trading account may require a significant amount of money deposited as initial and maintenance margin. Since employee stock options are not a liquid derivative security, they are largely unregulated and cannot be used as collateral in an equity trading account to reduce margin requirements.

Since employee stock options are only call options, the employee could sell a listed call option with a higher strike price that is expected to expire worthless for some extra income. Alternatively, they could short the stock itself if they thought the stock was likely to decline and wanted to convert their employer-issued call option into a synthetic put option. They would also want to make sure that any listed call options they wished to sell expired before or on the same date as their employee stock option.

Copyrighted 2020. Content published with author’s permission.

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Stock plans at a glance

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Restricted stock units
An award of units where access to stock or cash is restricted until certain vesting conditions are met by the employee.

Employee stock purchase plans
A type of stock plan that allows employees to purchase shares of company stock via accumulated payroll deductions, sometimes at a discount.

Stock option plans
A grant that offers you the right to exercise or purchase shares of company stock at a pre-established price after a specific vesting period.

Restricted stock awards
An award of company shares where access to the stock is restricted until certain vesting conditions are met by the employee.

Stock appreciation rights
An award that allows the holder to profit from the appreciation in value of a set number of shares of company stock over a set period of time.

Performance awards
Typically, a grant of company shares or units where the recipient’s rights to the award are based on pre-established performance goals.

Understanding taxes

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