In an age where companies frequently cut corners, being offered “incentive compensation” like employee stock options can seem like a trick. Is your company trying to get out of giving you more money, or are employee stock options worth their weight? Before we break down the pros and cons, let’s give you some vocabulary:

• • Employee Stock Option: The option – or the right – to purchase a share of the company stock at a predetermined price over a certain period of time.

• • Grant or Exercise Price: The predetermined price at which you can purchase shares of the stock. For simplicity, we’ll just refer to it as the grant price.

• • To Exercise: No, not lifting weights. This means the action of purchasing your underlying shares of stock.

• • Number of Shares: The number of shares you’re entitled to purchase under the terms of the company agreement.

• • Vesting Period: The amount of time you must wait before you’re entitled to exercise your options.

• • Value: The difference between the market price and the grant price of the stock, multiplied by the number of shares you’re entitled to purchase.
  • Expiration Date: Yep, you guessed – when your options are no longer valid.

Why would a company give you employee stock options?

The number one goal of a business owner is to increase the value of their business. Offering employee stock options is one way to retain employees (thereby decreasing turnover costs) while motivating them to work harder. If employees have a stake in the company vis a vis stock options, they will work toward the success of the company. The value of the business will grow, which means your stock prices will, too. It’s a win-win for owner and employee.

What are my options worth?

Let’s say you have the right to purchase 1,000 shares of your company’s stock at $10 per share once your options vest for 10 years. At any point after the vesting period, you write a $10,000 check to purchase 1,000 shares of stock for $10 per share.

At the time you were awarded this option, your company’s stock was trading around $10 a share. Now, the stock is worth $50 a share, making your employee stock options worth a whopping $40,000! How did I get that number? Take the current value of the stock price ($50), multiplied by how many shares you own (1,000), minus the cost of their purchase ($10,000).

Should I exercise my employee stock options?

A $40,000 value makes a persuasive argument for exercising your options. But after you do, is it worth cashing in to get that money? It depends on if you agree with the value of the company reflected in the current share price. If you think the value of the company is worth significantly more than $50 a share, you might want to hang on to your options.

You see, your right to purchase shares are only worth something if the current value of the stock is greater than the grant price. For example, if the value of your company stock were to fall to, say, $9 a share, your options would be worthless. Why would you choose to purchase something at $10 that you can buy for $9?

Make sure to ask yourself how exercising the options fits into your overall financial plan. Remember that you want a diversified portfolio to ensure you don’t have too much of your net worth tied up in your company’s stock. That way you’re not relying on one resource when you want to buy a home or achieve some other financial goal.  

Read: Checking-in With Your Financial Goals: A Key to Financial Success

Wait, what was that thing about needing to write a check?

When it comes time to exercise your stock options, remember it is the right to purchase shares of your company’s stock, which means you’ll need to pony up the cash to purchase them. Shockingly, not all of us have $10,000 lying around. An alternative to using your own money is called a “cashless exercise” where you use some of your options to purchase shares in the company stock.

But don’t exercise your options yet!

While employee stock options may sound enticing, it’s important to consider how they fit into your overall financial plan. Consulting with a financial advisor can help you determine when and if to exercise your stock options, what the tax implications are (they can be complex!), and whether or not you should hold onto your stock after you’ve exercised your options.

Employee stock options can make you think you’re losing out on actual money. But if you do your research and follow your instincts, there’s a good chance that you can turn your options into real cash down the line.

If you’re interested in financial planning services, please reach out with any questions.

Jim Marrocco, CFP®, CFA

Jim is a financial advisor and owner of Thinking Big Financial, Inc. Thinking Big Financial is a fee-only registered investment advisor offering financial planning and investment management services. Specializing in working with the LGBTQ Community.

Please read my legal disclaimer here.