Sharekhan Blog

What are Stock Options Trading & How do they work?

  • Apr 14, 2024

Selecting the best compensation package and managing your options wisely will be made easier if you have a clear understanding of "what are stock options," how they operate, and the benefits of options stocks. You may read all about stock options, their advantages, and a few other relevant topics in this blog post.

Stock Options Trading Meaning

Probably the most well-known type of equity compensation is option trading stocks. The right to purchase a certain quantity of business stock at a predetermined price, referred to as the "exercise" or "strike price," is what a stock option entails. Over a predetermined amount of time, known as the "vesting period," you actually become the owner of granted options. Options vesting indicates that you have "earned" them, but you still have to buy them.

The online dashboard provided by Empower allows you to monitor your stock options over time. Whether or not your firm has gone public, you may use the stock options calculator to keep track of the actual and expected value of your stock options as well as their vesting timeline.

Types of Stock Options

There are mainly two types of options trading in stocks. They are: -

1. Call option

Call options grant the holder the right, either before or on the expiration date, to purchase a certain number of shares at a certain price (referred to as the "strike price"). For investors who think that the price of the stock will increase in the future, this kind of option is advantageous.

2. Put option

The right to sell a certain number of shares at a predefined price is granted to the holder of a put option before or on the expiration date. For investors who think there will be a decline in the stock price in the future, this kind of option is advantageous.

What are the Benefits of Stock Options?

1. Possibility of larger returns: In comparison to other investments, stock options have the potential to yield larger profits. You have the chance to make money as an investor by purchasing stocks at a discount and selling them for a premium.

2. Flexibility: The timing of when you can exercise your stock options is flexible. This gives investors the freedom to decide when, in light of the state of the market, to purchase or sell their stocks.

3. Risk management: Since options contracts have a predetermined expiration date, investors can control their risk and choose the best time to exercise their options.

4. Leveraged investments: You can control more shares with a smaller investment when you use stock options. This makes it possible to potentially earn larger returns without making big initial capital investments.

5. Employee incentives: Since stock options provide employees a stake in the company's performance and connect their interests with the shareholders, they can also be utilised as an incentive for staff members.

How Do Stock Options Work?

Let’s discuss how stock options work: -

1. Option Grant

When a business gives stock options to a worker or investor, that is the first stage. This typically takes place as a means of funding the company from investors or as part of staff remuneration.

2. Vesting Period

Before the holder can exercise their options, there is often a vesting time after the option grant is granted. This implies that before the holder can purchase or sell their shares, they must wait a certain amount of time, referred to as the "vesting period".

3. Exercising Options

The holder can decide to exercise their options by buying stocks at the predefined price after the vesting period has passed.

4. Selling Options

After buying the stocks, the holder has the option to either sell them right away or save them for a later time.

5. Profit/Loss

By selling their shares at a higher price, the holder benefits if the stock price rises over the strike price at the time of exercise. Nonetheless, they have the option to let their options expire without exercising them if the stock price drops below the strike price.

How to Exercise Stock Options?

When the time comes to exercise the options that you have, there are usually a few different ways to do so:

1. Payment in cash: If you want to exercise your options at the strike price, you can raise the necessary funds.

2. Exercise without cash: In certain cases, your employer may let you exercise your options by selling enough of them to offset the expense of exercising the rest.

3. Exercise and sale without the need for cash: If your company permits you to exercise and sell your options right away at the going rate, you won't be exposed to stock price volatility in the future, and you won't need to pay cash upfront.

The Bottom Line

Both companies and investors may find that stock options are a useful instrument. They have risks that should be carefully evaluated, but they also provide the potential for larger returns and more flexibility. We hope that after reading this article, you will know more about stock options and how they operate.

Team Sharekhan
by Team Sharekhan

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