Are stock options a good idea

Options are more popular now than ever as an investment option. The perks to options include cost efficiency, less risk, higher potential returns.
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Spreads have limited risk and limited rewards. However, in exchange for accepting limited profits, spread trading comes with its rewards, such as an enhanced probability of earning money. The somewhat conservative investor has a big advantage when able to own positions that come with a decent potential profit—and a high probability of earning that profit. Stock traders have nothing similar to option spreads.

Options trading is not stock trading. For the educated option trader, that is a good thing because option strategies can be designed to profit from a wide variety of stock market outcomes. And that can be accomplished with limited risk. The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors.

Should I Buy My Stock Options After Leaving A Startup?

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Different Trading Skills Required

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10 Tips for Dealing with Startup Stock Options

At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. By joining a start-up an employee has the opportunity to obtain an equity stake at a low valuation in the enterprise with the hope that one day that equity stake will be worth a significant amount. By granting equity rights to the employees, the employees are no longer just workers — they are also owners. When you are an owner, your work is not "just a job," and you are more willing to take on responsibility and take pride in your work-product. The most typical way of granting employees an equity ownership in a company is by the issuance of stock options.

A stock option gives an employee the right to buy a fixed number of shares in a company at a fixed price over a certain period of time.

Historically, ISOs were created to provide a tax-efficient way of granting equity to employees. The tax advantage of an ISO is that there is not tax on the date of grant of the option and there is not tax on the date of exercise.

That said, the tax benefits attributable to ISOs may in fact be somewhat illusory. Although there is no tax on the date of exercise, the amount of gain between the exercise price and the fair market value may be considered for AMT alternative minimum tax purposes by the IRS. Thus, an employee who exercises his option may, under certain circumstances and depending on each employee's personal tax situation, have to pay taxes under the AMT provisions, even though he or she may not have realized any cash yet from his or her options if he or she has not in turn sold the stock received upon exercise of the options.

Secondly, in order to obtain long-term capital gains treatments on the options, the employee must hold the stock received upon exercise of the option for at least one year before selling. As such, the employee will have to bear the market risk that the stock price may go down below the exercise price of the stock options before he or she sells his stock.

This set of circumstances may result in the employee actually losing money on the options! Because most employees do not wish to take the market risk that the stock received will go down in value, most employees exercise the options and sell the underlying shares on the same day.

The result of this is that the employee receives short-term capital gains treatment on the sale of the stock, which is the same taxable rate as ordinary income. Since the ordinary tax rates are significantly higher than long-term capital gains rate, the purported tax benefit of obtaining ISOs is often nonexistent.

One of the most vexing problems for companies and their board of directors is determining the fair market value of its Common Stock for purposes of calculating the exercise price. In a public company, determining the fair market price of stock is made quite easy by looking at the closing price on the company's stock as quoted on the appropriate exchange or electronic market.

For private companies, the task is not so simple. Stock options are generally granted for shares of Common Stock.

How Do Employee Stock Options Work

The shares purchased by a venture capital firm are for Preferred Stock. By the terms of the Preferred Stock, it is senior in liquidation and in dividends to the Common Stock. Because the Preferred Stock is senior in terms of liquidation and in dividends, the Common Stock is less valuable than the Preferred Stock.