A Simple Guide to Stock Options & Their Tax Impact

A stock option is an agreement between a buyer and a seller to exchange stock for a pre-set price within a specific period. Employee stock options, for example, are agreements between the corporation and the employee to purchase common stock at a price set by the corporation. The stock must be purchased within a specified time, or else it expires. Many companies do not defer to offering stock options as a benefit to their employees. 

Exercising a stock option means executing the purchase at the preferred price. When the price provided by the seller is below the market price, then exercising the option seems like a good decision. If the offered price is above the market price, it's usually not a good idea to exercise the option just yet.

Vesting and Expiration

Some options become immediately available upon the agreement, but others don't. The stocks that don't instantly become available for exercising the option have a vesting date, which refers to the earliest time a buyer can exercise their option. Many employee packages have a vesting date, ensuring that employees don't immediately sell their common stock options. 

Expiration is a feature of all options, since they are time-limited. If the buyer doesn't exercise their option to purchase by the expiration date, they lose that option. Many investors use options to earn more money on their shares by offering options on the market. Buyers usually snap up these options hoping that the stock price will go in one direction or another, but wind up letting them expire when the prediction doesn't pan out.

Entries for Stock Option Exercises

In accounting, when options are exercised, there are typically three common entries that are used: