What the hell are stock options as part of a salary and how do they work?

Question

Self-explanatory. I’m clueless. I just want to know how much money I’m going to be getting every month in total for my job.

In: Economics

Answer 1

The basic idea is that you get the OPTION to buy the stock at a certain price, and the company has an OBLIGATION to sell you stock at that price, typically at some time in the future.

So first let’s talk about time: There is a grant date, which is the date that the company gives you the option. There is a vesting date, which is the date when you can finally exercise your option. And there is an expiration date, after which your option is worthless.

Now let’s talk about stock prices: There is a strike price, which is the price at which you are allowed to purchase. For a public company, this is typically the closing price on the grant date. And there is the fair value at the time that you exercise it.

How much you make is the difference between the fair value and strike price. Let’s say you got 500 options $100 on Jan 1, 2021 vesting 3 years later. Then on Jan 1, 2024, the stock was worth $130. You can get $1500. Congrats!

But how do you get the money? Most companies will offer a cashless exercise, which means that you don’t need to come up with the $5000 to purchase your $6500 of stock. They’ll just pay you the difference either in stock or cash.

Now, let’s say the stock wasn’t worth $130 on the vesting date but only $90. Well, you wouldn’t exercise the option because you could already buy the stock for less than the option is worth. That’s where the expiration date comes in. Maybe your options expire in 5 years. You can wait until the stock price goes above the strike price, and exercise then.

Now, you really want to know how much this compensation is worth. That’s VERY complicated. There are ways to calculate it. For a common stock, they will often use Black Scholls. That’s how they decide how many options to give you. Let’s say your comp is $100k cash + a 20% target for options. They company uses the Black Scholls model to figure out how many options are required for a $20k present value.

This isn’t really ELI5, but five year olds don’t get paid in options.