What Are Stock Options and How Do They Work?

stock-options

Stock options are often part of a benefits package for middle managers and executives at large corporations. Employee stock options aren’t traded on an exchange like traditional options trading. They do; however, work in a similar way.

Whether you’re taking advantage of stock options from your employer or trading options on your own through a trading account, you need to know how these investment vehicles work and what they can do for your overall wealth. Below is a rundown of everything you need to know about stock options.

What Are Stock Options?

When it comes to employment agreements, stock options are contracts that give the employee the option to purchase a certain number of shares in the company stock at an agreed-upon price. These contracts have to vest — another word for mature — for the employee to take advantage of them.

Essentially, stock options are both an incentive and a retention strategy. Since employees have to wait for their options to vest, they’re encouraged to avoid looking for work elsewhere. If they quit before the vestment period ends, they don’t get to exercise their options.

The idea behind stock options is to give employees a stake in the company, often at a reduced rate per share. They can be used as an extra means of income outside of salary and other benefits, which might make a position more lucrative.

Stock options also exist on the various stock exchanges. You can purchase the option to buy a stock at a specific price by a specific date. You’re not required to follow through with the contract, but you will lose your initial investment.

What Is the Difference Between Stock Options and Options Trading?

In most cases, the term “stock options” refers to employee stock options given by an employer, while options trading refers to options contracts carried out on the open market. Anyone can participate in options trading, while only employees offered stock options can take advantage of the former.

Both types of investments work similarly, though you will need a far more complex strategy for options trading. You’re making an educated guess that a particular stock’s price will increase or decrease over a period of time, then enter into a contract based on your prediction. If the stock price moves against you, simply don’t follow through on the contract.

Should Employees Consider Stock Options When Accepting Jobs?

If you’re interested in building long-term wealth, stock options can help secure that for you. Of course, they are more valuable when they come from a large or incredibly stable company simply because if your employer’s stock price tanks, you can lose money on the deal.

As mentioned above, though, employee stock options usually come at a discount off the going market rate. In other words, what you pay for your shares when exercising stock options through your employer will probably be less than what you’d pay by investing on a stock exchange yourself.

The same can’t be said for options trading. You have to consider the bid-ask spread, volume, volatility, and historical markers. If you’re not familiar with stock options or options trading, you might consider signing up for The 10-Minute Millionaire Insider. I provide lots of tips and advice for profiting from stock options.

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How Can You Get involved in Options Trading?

You’ll likely need a margin account if you want to start options trading. In most cases, you’ll buy lots of 100 shares each in an options contract if you decide to go through with it. Some investors use their money to execute the contract, while others borrow from their brokers.

How Does Options Trading Differ From Buying and Selling Stock?

Options trading is completely different from simply buying, selling, or shorting stock. Instead of executing a trade immediately, you decide you want to execute a trade in the future, whether it’s 30 days or 120 days, or somewhere in between.

The great thing about stock options and options trading is that you’re not locked into it. The stock price might move against you, in which case your losses are fixed. This is completely different from a situation in which you buy shares of a stock whose price plummets. If you can’t get rid of the stock on the open exchange, you could lose far more than you would under an options contract.

How Are Options Different From Futures?

Stock options and futures contracts are also different. An option, whether from an employer or on an exchange, means that you can decide whether you want to fulfill the contract. If you’re buying a futures contract, you’re locked into the agreement.

You still have time to exercise the futures contract. You could wait a day or wait until expiry — whatever benefits you most. However, stock options are considered less risky because of the option to bail on the contract.

Conclusion

Whether you’re getting stock options from an employer or engaging in options trading on the open market, you need guidance. The more you know about how to navigate Wall Street, the more confident you’ll become as you generate more income from trading.

To get the best possible tips and tricks on options trading, sign up for The 10-Minute Millionaire. I send out stock picks and other useful information to help you become a more savvy investor without all the time-consuming research. Plus, you can follow my protocol in just 10 minutes a day.

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