Have you ever wondered what the difference is between options trading and employee stock options? I know I did when I first started trading options. I would say most stock and mutual fund traders don’t know either. So if you’re not real sure yourself, check out the following article. Jay does a great job of explaining the difference between the two.
By: Jay Hawk, dated February 22nd, 2012
Employee stock options have made employees at some companies instant millionaires. Companies such as Apple (AAPL), Microsoft (MSFT), and many other high tech firms have kept a good executive staff and a growing company thanks to awarding employees with participation in the ownership of the firm.
The main difference between options trading and employee stock options is the fact that options trading involves buying and selling options as a speculative endeavor, while employee stock options are generally used as a form of compensation that a company offers employees as an incentive.
Another major difference between the two is that employee stock options have no formal exchange listing and can only be exercised within the company on the stated terms that the company has provided the options under.
These terms include the price at which the employee has the option to buy the stock and how much stock the employee can purchase. Also, employee stock options sometimes have a time limit within which the options can be exercised.
Listed Stock Options
Listed stock options are typically highly regulated and very liquid derivative financial products with values linked to the price of the underlying stock, as well as other factors like the stock’s expected volatility.
This type of option trades on an exchange and can usually be exercised at the strike price by the buyer at any time during the life of the option. The buyer can also choose whether the option is an option to buy the stock, a call option, or to sell the stock, a put option.
Employee Stock Options
On the other hand, an employee stock option is typically issued by a company to its qualified staff as a bonus and involves the firm granting the employee an option for them to buy or call a specific amount of the company’s stock at a specific price. The stock can be the company’s common stock or an issue of restricted stock set aside for this specific purpose.
The company sets the amount of shares that can be bought using the option, the strike or exercise price and an expiration date for the option. Some employee stock options have no expiration date and can be redeemed by the employee at any time.
This gives the employee an incentive to make the company more successful, since the price of the company’s stock will generally rise if the company does well. Employee stock options make up an important part of many executives’ employment contracts, although companies can also extend employee stock option plans to their other staff members.
How to Trade Listed Stock Options Against Employee Stock Options
If the employee works for a large corporation that has its stock and options listed on major exchanges, then they may be able to sell listed options or stock against their employee stock call options that act as a hedge. An exception would be if the stock obtained from the exercise of an employee option is restricted so that the employee cannot to use it to cover a short position in the company’s common stock.
Also, before trading against their employee stock options, they need to be aware that selling naked options in an equity trading account may require a significant amount of money deposited as initial and maintenance margin. Since employee stock options are not a liquid derivative security, they are largely unregulated and cannot be used as collateral in an equity trading account to reduce margin requirements.
Since employee stock options are only call options, the employee could sell a listed call option with a higher strike price that is expected to expire worthless for some extra income. Alternatively, they could short the stock itself if they thought the stock was likely to decline and wanted to convert their employer-issued call option into a synthetic put option. They would also want to make sure that any listed call options they wished to sell expired before or on the same date as their employee stock option.
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