INVESTING EXPLAINED: What you need to know about stock options, which give an investor right to buy or sell a share at fixed price by a set date
In this series, we bust the jargon and explain a popular investing term or theme. Here it’s stock options.
What are they?
A stock option gives an investor the right – but not the obligation – to buy or sell a share at a fixed (or ‘strike’) price by a set date. There are two types of option.
A ‘call’, which is a bet that the share will rise, and a ‘put’ which is a bet that the share will fall.
The price for the option paid by the buyer to the broker that ‘writes’ the options is called the ‘premium’.
Speculate to accumulate: Adventurous investors like options because they can make a large gamble with a small outlay
Investors with a taste for speculation like options because they can make a large gamble with a small outlay.
An option is a ‘derivative’, so-called because its value derives from that of the underlying asset – the share.
Are options risky?
Definitely. Billions of option deals are traded every day, and it is possible to buy stop-loss protection to limit losses.
But, as many private investors have found to their chagrin, options may be exciting but are also an easy way to lose money.
It is said that when market professionals note that private investors are buying call options, the professionals see this as an opportune moment to take an opposite bet.
Do executive share options work in the same way?
Share options are a way to reward employees or key executives – and, crucially, retain their long-term loyalty.
The recipients are allowed to buy shares in the company at some time in the future at a pre-approved exercise price. They may also be able to avoid income tax or national insurance on the value of the shares.
There are various types of scheme, all with different tax and other rules: Save As You Earn (SAYE), Company Share Option Plan (CSOP), Share Incentive Plan (SIP), Enterprise Management Incentives (EMI) and Employee Ownership Trust (EOT).
Do these schemes have downsides?
Yes. The firm may be trying its best to win the goodwill of its workforce.
But sadly it cannot guarantee that its share price will rise, particularly at a challenging time for the economy. If the share price performs badly, the employees’ or executives’ share options can be ‘underwater’ – the exercise price is greater than the current market value of the shares.
Why are we reading about stock options at present?
The woe over underwater share options may be widespread but seems to be deepest at US tech companies.
The Silicon Valley giants saw stock options as a convenient – and low-cost – way to attract and retain talent in a competitive labour market.
Shares in some of these firms have fallen sharply, however, which means that staff who were promised wealth beyond their imagining are feeling hugely disappointed.
How are these tech companies responding?
The boss of Peloton, the US home fitness equipment firm, is trying to turn around the company whose stationary bikes are much less in demand than during the pandemic.
Options granted to staff had an exercise price of $27.62 (£22.95) and so were underwater. They will now be repriced to $9.13 (£7.58) to help win the staff’s co-operation with changes at the business.