Employee Stock Option

An employee stock option (ESO) is a call option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package. The objective is to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee could exercise the option, pay the exercise price and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and the exercise prices. If the market price falls below the stock exercise price at the time near expiration, the employee is not obligated to exercise the option, in which case the option will lapse. Restrictions on the option, such as vesting and non-transferring, attempt to align the holder's interest with those of the business shareholders.

Employee stock options are mostly offered to management as part of their executive compensation package. They may also be offered to non-executive level staff, especially by businesses that are not yet profitable, insofar as they may have few other means of compensation. Alternatively, employee-type stock options can be offered to non-employees: suppliers, consultants, lawyers and promoters for services rendered. Employee stock options are similar to exchange traded call options issued by a company with respect to its own stock. Employee stock options anytime before exercise, have two components "time value" and "intrinsic value". The remaining "time value" component is forfeited back to the company when early exercises are made.

Stock option expensing became a controversy in the early 2000s, and it was eventually determined by the Financial Accounting Standards Board that the options should be expensed at their fair value as of the grant date.

Managing employee stock options efficiently requires the holders to sell exchange traded calls or buy puts as it is impossible to do so otherwise.