How are employee stock options and RSUs different?

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Two of the most common employee stock plans, employee stock options (ESOs) and restricted stock units (RSUs), both give you the chance to eventually become a shareholder in your company. While these benefits may sound very similar, there are significant differences between them.

 

An employee stock option is the promise that, at a future date, an employee has the option to buy company stocks at a certain price. A restricted stock option is the promise that, at a future date (or upon the accomplishment of another milestone or benchmark), an employee will receive company stocks.

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An employee stock plan may be offered to everyone as a companywide benefit. Other times, it’s a custom plan that’s baked into an executive job offer as either a recruitment and retention incentive, a way to cover the lack of cash flow in a startup, or both. Sometimes, employees get a choice between ESOs and RSUs. Understanding how each stock plan works, how they differ and exactly what the risks are with each can help you make a decision that best aligns with your financial goals.

 

This guide outlines the key features of ESOs and RSUs and breaks down the differences between them, so you can better decide what’s right for you.

 

Related: The ultimate list of financial ratios

Employee Stock Plans: Key Terms and Phrases

Having a grasp of stock market vocabulary can help you decipher quickly what your employer is offering, the terms and restrictions and whether it’s a good deal for you.

The Grant/Strike/Exercise Price

These are three different words with the same meaning: grant, strike and exercise price all refer to the price at which your plan says you can purchase company stock. It’s most often based on the stock’s current market value. If your strike price is 1,000 shares at $1 per share, for example, that’s what you’ll pay for those shares if you decide to exercise your stock options, regardless of their current market price.

Being ”In the Money” and “Out of the Money”

When the stock is currently trading above the strike price, it’s called being “in the money” and may mean big profits. Conversely, if the stock’s market price falls below the strike price, your options are considered “underwater” or “out of the money” and don’t hold any value. In that situation, it may be cheaper to buy your company’s stock on the open market.

What Are Employee Stock Options (ESOs)?

An ESO is an option to buy shares in your employer company in the future for a price set today. The “option” part means you can buy the stock later if it suits you, but you aren’t obligated.

 

Unlike an outright stock purchase, an option doesn’t give you actual shares until you decide to buy them, which is called exercising. Another difference from a traditional stock purchase is that options become null and void if you don’t exercise your stock options before the expiration date.

How do ESOs Work?

Generally, ESOs operate in four stages, starting with the grant date (aka strike date or exercise date) and ending with the exercise, or actually buying the stock.

 

1. The grant date. This is the official start date of an ESO contract. You receive official information on how many shares you’ll be issued, the strike price (aka grant price or exercise price) for those shares, the vesting schedule, and any requirements that must be met along the way.

 

2. The cliff. If a compensation package includes ESOs, it doesn’t necessarily mean that they’re available on day one. Contracts often contain a number of requirements that must be met first, such as working full time for at least a year. Those 12 months when you are not yet eligible for employee stock options is called the cliff. If you remain an employee past the cliff date, you get to level up to the vest.

 

3. The vest. When you pass your cliff date, your vesting period begins, which means you start to take ownership of your options and the right to exercise them. Vesting can either happen all at once or take place gradually over several years, depending on your company’s plan.

 

One common vesting schedule is a one-year cliff followed by a four-year vest. On this timeline, you’re 0% vested the first year (meaning you aren’t eligible for any options), 25% vested at the two-year mark (you can exercise up to 25% of the total options granted), and so on until you own 100% of your options. At that point, you’re considered fully vested.

 

4. The exercise. This is when you pull the financial trigger and actually purchase some or all of your vested shares. One common timeline is 10 years from grant date to expiration date, but specific terms will be in a contract.

Pros and Cons of Employee Stock Options (ESOs)

If you land a job with the right company and stay until you’re fully vested, exercising your employee stock options could lead to instant, huge gains. For example, if your strike price is $30 per share, and at the time of vesting the stock is trading at $100 or more per share, you’re getting a great deal on shares.

 

On the other hand, if your strike price is $30 per share and the company is trading at $10 per share, you might be better off not exercising your employee stock options.

Tax Implications of Employee Stock Options

Generally speaking, employers offer two types of stock options: nonqualified stock options (NSOs) and incentive stock options (ISOs). NSOs are the most common and often the type offered to the general workforce.  NSOs are subject to income tax on the difference between the exercise price and the market price at the time you purchase the stock. (ISOs are “qualified”, meaning you don’t pay any taxes when you exercise the options—only when and if you sell them at a profit later on.)

 

Any money you make above and beyond that if you sell your shares later can also be subject to the capital gains tax. If you hold your shares less than a year, the short-term capital gains tax rate equals your ordinary income tax rate, which could be up to 37% for the highest tax bracket.

 

For assets held longer than a year, the long-term rate can be 0%, 15% or 20%, depending on your taxable income and filing status.

What Are Restricted Stock Units (RSUs)?

Restricted stock units, or RSUs, fall somewhere in between stocks and options—they are a promise of stock at a later date. When employees are granted RSUs, the company holds onto them until they’re fully vested.

 

The company determines the vesting criteria—it can be a time period of several years, a key revenue milestone or even personal performance goals. Like ESOs, RSUs can vest gradually or all at once.

How Do Restricted Stock Units (RSUs) Work?

RSUs are priced based on the fair market value of the stock on the day they vest, or the settlement date. This means that you don’t have to worry about falling out of the money—the company stocks you receive from your company will be worth just as much as they would be if you purchased them on your own that same day.

 

As long as the company’s common stock holds value, so do your RSUs. Upon vesting, you can either keep your RSUs in the form of actual shares or sell them immediately to take the cash equivalent. Either way, they will be taxed as income.

Pros and Cons of Restricted Stock Units (RSUs)

One good thing about RSUs is the incentive they can provide to stay with the company for a longer period of time. If your company grows during your vesting period, you could be very far in the money when your settlement date rolls around.

 

But even if the stock falls to a penny per share, they’re still awarded to you on your settlement date, and they’re still worth more than the $0 you paid for them. In fact, you may only lose out on money with RSUs if you leave the company and have to forfeit any units that aren’t already vested, or if the company goes out of business.

Tax Implications of RSUs

When your RSU shares or cash equivalent are automatically delivered to you on your settlement date(s), they’re considered ordinary income and are taxed accordingly. In fact, your RSU distributions are actually added to your W2.

 

For some people, the additional RSU income may bump them up a tax bracket (or two.) In those cases, if you’ve been withholding at a lower tax bracket before your vesting period, you could owe the IRS even more. As with ESOs, if you sell your shares at a later date and make a profit, you’ll be subject to capital gains taxes.

The Takeaway

Knowing how ESOs and RSUs work—and understanding the differences between them in terms of terms, pricing and tax implications—can help you make an informed decision if and when you are offered one or both of these workplace perks.

 

Having the option to own stock in your employer company has the potential to provide attractive financial benefits, especially if you believe in the company and its future. However, one key investing strategy that many investors follow is portfolio diversification—making sure your investments are spread out across companies, industries and assets.

 

Here’s why: Because if all your investments are in company stock and the business folds or takes a downturn, you risk losing both your salary and your stock.

 

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

 

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The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA SIPC. SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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5 important options trading strategies

 

Options contracts represent agreements that give an investor the right — and in some cases, the obligation — to buy or sell a particular security at a specific price by a set date in time. A single contract typically represents the right to buy or sell 100 shares.

Options involve two main elements: a strike price and an expiration date. The expiration date is when the contact is due, and the strike price is the price at which a contract must be delivered upon.

Interested investors who have already read a guide to options trading might be ready to go deeper and learn more about option trading strategies.

Related: 6 real questions about investing— answered

 

Pinkypills / istockphoto

 

The two most basic types of options are calls and puts.

A call gives an investor the right to buy an asset — it’s a bet that the price will rise.

A put gives an investor the right to sell an asset — it’s bet that the price will fall.

Combinations of calls and puts with different strike prices and expiration dates can be used to create different option trading strategies.

 

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There are a few ways investors might use options in an effort to realize a profit or generate some income.

When using options, investors can either buy existing contracts, or they can “write” contracts for securities they currently hold. The former is generally used as a means of speculation, while the latter is most often used as a way of generating income.

There are also three categories contracts can fall into, depending on where the price of their underlying security lies in relation to their strike price.

  1. “In-the-money” means an option is already profitable (i.e., the stock price is below the strike for a put, or the stock price is above the strike price for a call).
  2. “Out-of-the-money” means the opposite (i.e., the stock is trading higher than the strike for a put, or the stock price is trading lower than the strike for a call).
  3. “At-the-money” means the strike price of the option and the stock price are about the same.

 

GaudiLab // istockphoto

 

The covered call strategy requires an investor to own shares of the underlying stock. They then write a call option on the stock and receive a premium payment.

The tradeoff is that if the stock rises above the strike price of the contract, the stock shares will be called away from them, and the shares (along with any future price rises) will be forfeit.

So this strategy works best when a stock is expected to stay flat or go down slightly.

If the stock price stays below the strike price when the option expires, the call writer keeps the shares and the premium and can then write another covered call if desired. If the stock rises above the strike price when the option expires, the call writer must sell the shares at that price.

 

Lazy_Bear / istockphoto

 

The cash-secured put strategy is one that can both provide income and let investors purchase a stock at a lower price than they might have been able to if using a simple market buy order.

Here’s how it works: An investor writes a put option for a stock they do not own with a strike price lower than shares are currently trading at. The investor needs to have enough cash in their account to cover the cost of buying 100 shares per contract written, in case the stock trades below the strike price upon expiration (in which case, they would be obligated to buy).

This strategy is typically used when a stock is expected to go down in the short-term. The option writer then receives cheap shares while also holding onto the premium.

Alternatively, if the stock trades sideways, the writer will still receive the premium, but no shares.

 

Tzido/ istockphoto

 

The previous two option strategies only involve one option “leg,” meaning there’s only one contract involved. More sophisticated strategies — like the bull put spread — involve writing or buying multiple options contracts at the same time to minimize risk.

A bull put spread involves one long put with a lower strike price and one short put with a higher strike price.

Both contracts have the same expiration date and underlying security. This strategy is intended to benefit from a rising stock price. But unlike a regular call option, which also benefits from a rising stock price, a bull put spread can also profit from time decay.

 

Antonio_Diaz/ istockphoto

 

The condor consists of four call option legs (two written calls and two buys of existing calls) and is designed to earn a small profit in a low-risk fashion when a stock is thought to have little volatility (Understanding stock volatility is important for any investor).

A trader can create a condor by writing an in-the-money call with a lower strike, buying an in-the-money call with an even lower strike, writing an out-of-the-money call with a higher strike, and buying another even higher striking out-of-the-money call.

 

Sitthiphong / istockphoto

 

Like the condor, the butterfly spread involves four different options legs. This strategy is used when a stock is expected to stay relatively flat until the options expire.

A butterfly spread is a combination of a bull spread and a bear spread and can be constructed with either calls or puts. In this example, we’ll use calls.

To create a butterfly spread, an investor can buy one in-the-money call with a lower strike price, write two at-the-money calls and buy another higher striking out-of-the-money call.

 

NicoElNino / istockphoto

 

The average brokerage account should have most of these options available for selection, provided there are enough existing options contracts for a given security.

After choosing the type of strategy, an investor will have to pick the strike price and expiration date of each option leg. Inexperienced options traders, in particular, might want to consider sticking to strategies that only involve one option leg while learning how options work.

Most brokerages have different “levels” for trading options. New investors might only be able to write covered positions only. To use more advanced strategies like condors and butterflies, investors might have to take a short quiz demonstrating their understanding.

 

Prostock-Studio / istockphoto

 

Sometimes, options can be used as a hedge. A hedge is something an investor uses to make up for potential losses somewhere else.

For example, gold is often referred to as an “inflation hedge,” because gold tends to perform well during times of inflation, even though the currency other investments are denominated in would be going down in real terms.

Likewise, traders can use various options trading strategies to hedge their existing portfolio positions.

One example might be an investor who is heavily invested in tech stocks, placing a put option on a tech-heavy ETF or index fund like the QQQ.

The QQQ ETF tracks the Nasdaq 100 index, a list of the top 100 best-performing stocks on the Nasdaq stock exchange, which is mainly geared toward tech companies (although there are other types of companies included as well).

In an effort to hedge a large long position in tech, an investor could possibly consider placing a long-term put option on the QQQ (typically more than 9 months). In theory, this put option would then rise in value if tech stocks took a beating. In this way, an investor could minimize losses.

Of course, the opposite also holds true. If tech stocks continue to rise, then the QQQ put option would lose value. In either case, the allocation is what’s important — determining what amount of money to place in each investment to create a balanced portfolio.

In this example, allocation would need to be calculated in a way that would ensure tech stock gains would outpace potential put option losses and vice versa. Asset allocation is a complex topic that is unique to each individual investor.

 

oxtain/ istockphoto

 

While options can be used to hedge overall risk in a portfolio, trading options for profit can come with substantial risk.

Put options in particular can lead to large or even potentially unlimited losses for investors. Unlike a call option, in which a stock’s price has the potential to fall to zero, at which point maximum losses are realized, with a put option there is no upward limit on a stock’s price. Because of that, the put can continue losing more and more money if the stock keeps rising.

The other risk comes in the form of beginner investors not understanding what options contracts they are buying. When selecting a contract from an options chain, the choices can look confusing, and novice traders could easily misunderstand the actual bet they are making.

One way to remedy this might be to take advantage of any “paper money” trading options that brokerages offer. This sort of feature will allow traders to try different option strategies without risking real money.

Traders can learn from experience without losing by selecting different options and seeing how the results play out over time.

 

dima_sidelnikov / istockphoto

 

Options trading strategies offer a way to potentially profit in almost any market situation, whether prices are going up, down or sideways.

More option trading strategies exist beyond the common ones outlined here. There are many possible ways to combine options, some of them being rather complex.

Depending on how they’re used, options can come with a small amount of risk or an infinite amount of risk. In general, trading with instruments like options and futures is considered to be riskier than buying/selling stocks because these strategies require greater experience and understanding, and the risks involved might not always be as clear.

Learn more:

This article
originally appeared on 
SoFi.com and was
syndicated by
MediaFeed.org.

SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA  SIPC  . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer to sell, solicitation to buy or a pre-qualification of any loan product offered by SoFi Lending Corp and/or its affiliates.
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