Last updated on October 3rd, 2022 at 10:28 am
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As employers are encouraging a new generation of workers to join the workforce, more and more people are deciding to choose stock options as a sign-on benefit.
But common questions are beginning to arise, such as: why would someone use stock options? And should you use them?
Not only are stock options something that can come as a bonus from a company but they can also be purchased through brokerage companies. By purchasing these call or put options you can control many shares of a stock for a specific period of time.
Why would you want to do that?
Many people use stock options (calls or puts) as it allows them to have leverage. Instead of buying a few shares of a company they can control hundreds of shares with the same funds. This leverage allows them to get larger gains (if the stock does what they expect it to).
People use stock options because they provide a form of financial investment that can be low risk—deciding whether or not to use stock options is a personal choice. Today, stock options have also become an increasingly common form of financial compensation.
Individuals are given the right to purchase shares of a stock at a predetermined price, regardless of market value. However, stock options can be incredibly complex and are just starting to receive attention in the personal financed sphere.
Read on to learn more about stock options, why people use them, and if you should use them.
Using Stock Options
Though many people understand what stock options are, some people don’t quite understand how they are used.
Here is a quick example:
Suppose I was granted a stock option in the company abc123, at which the strike price was agreed to be $5. If abc123’s stock rose to a price higher than $5, I could purchase the stock at a discounted rate.
If the stock’s price then rose to $10, after purchasing it at $5, I would be making $5 from each share of stock.
The same is true in the inverse if I could sell stocks (called a put option) at a certain price. If I was allowed to sell my shares at the strike price of $10, for example, and the stock’s value fell to $5, I would be making an additional $5 on every stock I sold.
In choosing to sell the stock at that strike price, or in the above example, choosing to buy a stock at that strike value, I’m choosing to “exercise” my stock option.
Call or put options can also be sold on the open market rather than exercising them. This is how most traders realize a profit rather than actually exercising the option.
Why People Use Options
Understanding what stock options are, you can now understand why they can be useful and why many people increasingly decide to use them as a form of investment.
Ultimately, there are a few major benefits to using stock options vs just purchasing shares of a stock. Here are just a few:
- Stock options can be less risky for investors.
- Options present the possibility of high returns for investors.
- Stock options help growing businesses attract talented employees.
- Stock options give incentives for employees to work harder.
Let’s take a look at each of the benefits stock options can provide.
Stock Options Can Be Less Risky For Investors
Stock options are often considered a “low risk, high reward” option for those who maintain control of them.
Because stock options do not require that an individual buys or sells but rather just gives the owner the right to do so, this can ensure that you do not have as much potential for loss.
While there is certainly still potential for loss, as with any investment, this is limited to some extent to only what you paid as a premium. With options your gains are virtually unlimited while your losses are capped at what you paid for the option.
Options Present The Possibility Of High Returns For Investors
If you work for a rapidly growing business and whose stock’s value is increasing, being able to purchase a number of these stocks at a discounted price presents you with huge earning potential.
Imagine, for example, that in January of 2020, you were offered a strike price of $150 for one Tesla share. If you purchased even just 10 shares, you would have made more than $6,000 in profit in less than 2 years.
This would be a win for you from an investing standpoint.
Options not only present the possibility of high returns for investors when the stock is increasing but also when it’s decreasing.
Depending on the type of option you have, you may be able to sell the option; you can sell your ability to buy or sell stocks at a discounted price to another investor.
When this happens, even if the stock you have an option for is decreasing, you can still sell your option, making a return on your investment.
Stock Options Help Growing Businesses Attract Talented Employees
As a growing company, you are looking for the best and brightest talent to help your business grow even further. With stock options, you allow your employees to earn just a bit of their worth as the company grows.
When comparing your business to another offering a similar salary but no stock options, your company will have a competitive advantage. Those who know that their labor is worth a decent salary will instantly be attracted to your company.
Stock Options Give Incentives for Employees To Work Harder
Applying the same logic as above, by providing your employees with an incredibly small portion of ownership, good employees will be willing to work harder for your company, because they know they’ll receive some of the proceeds.
As a talented employee, a hard-working supervisor, or even as a chief officer, employees know that the more productive they are, the more money the business will make and the more they will make by proxy.
Stock Options Come With Risks
Though options are generally considered to be a safer form of investment than betting on traditional stocks, using stock options does not come without its risks.
Just like all other forms of stock investment, prices fluctuate rapidly and oftentimes without warning. This can make it so that you exercise a stock option before it is best for you to do so.
Your option (assuming it’s a call or put option) will also expire so if the stock doesn’t move up or down enough you might lose 100% of your investment in that contract.
Try to avoid trading in a volatile market!
Ultimately, deciding if stock options are the right choice for you is a personal decision that should be made with the assistance of either a financial planner or a stockbroker. Because everyone is in a different situation, there’s no “one size fits all” when it comes to investment plans or forms of financial compensation.
It’s true, however, that if you’re a new employee working at a rapidly growing company, or if you’re a growing company looking to hire and keep new, capable talent, stock options are definitely worth considering.