When I was hired, I was granted 1,000 ISO stock options. I have vested 500 and have not exercised any because I don’t really understand the implications of exercising them. What happens to the money I spend on them? What is the potential gain? What are the risks?
In: Economics
ISOs are like coupons to be used to pay for discounted shares of stock.
Let’s say the current stock price is $10 and your ISO discount or strike price is $5. When you exercise an option, you pay $5 to get something that is worth $10. If you sell it immediately, you get your $5 invested and $5 profit. However, that $5 profit will be taxed as income.
If you hold the exercised share for at least 2 years before selling, the profit will be taxed at the capital gains rate which is lower than the income tax rate.
The risk is that the stock ends up at a lower price than your strike price so it’s not worth using the options. These options also expire usually 10 years after the grant date. They may also be taken back if you leave the company. The stock may also lower after you exercised the options and hold on to stock.
These incentives help employees focus on working to build the company’s worth so the stock and thus the value of the ISOs goes up.
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