A share option, also known as a stock option, is a financial instrument that gives the holder the right, but not the obligation, to buy a share in a company at a predetermined price (called the strike price or exercise price) within a certain period of time.
Key Components
- Vesting Date: The date when the option holder earns the right to exercise the option.
- Strike Price (Exercise Price): The fixed price at which the option holder can buy a share.
- Expiration Date: The date by which the option must be exercised. After this date, the option expires and becomes worthless.
Payout Structure
The payout or payoff of an option depends on the difference between the market price of the underlying share at the time of exercise and the strike price:
- If the market price > strike price: The option holder profits by buying the shares at the strike price and potentially selling them at the higher market price. The profit is the difference between the market price and the strike price.
- If the market price ≤ strike price: The option expires worthless.
Example
You have 1 000 vested options in company X.
The strike price for exercising one option is 1.
The current share price in company X is 2.
You exercise all of your options by paying 1 000 (1 per option)
You receive 1 000 shares which is worth 2 000.
You just made 1 000.