Know Your Stock Options

Written by Kara Stefan

Stock options sound great but you need to weight the risks. Above all, make sure this is a company you believe in and you love your job.what to know about stock options

In the past, initial public offerings yielded wildly overpriced stocks, a bull-market phenomenon that was good for young executives trading high salaries and security for the higher risk/reward potential of a compensation package that included stock options in a start-up company.

Weighing Stock Options
Remember they are a long-term investment.
Make realistic estimates of the stock's potential value.
Research the volatility of the firm's shares.
Balance short-term needs and long-term goals.
Plan to work through at least a year before you actually own any stock. 
But this wasn't always the case, and a stock-options package may not be the right choice for you.

James Daniel, an employee benefits attorney and partner with Womble Carlyle Sandridge & Rice in Charlottesville, N.C., cautions, that often "there is a two- to three-year time frame where an individual might be hired with this expectation" of huge gains from the public offering. But if the company fails before its IPO, the employee's stock, and subsequent compensation, will be worthless.

Daniel says that stock options are most commonly offered in the technology and related industries. But this is not exclusive to high-tech firms; 96 percent of all publicly traded companies grant options.

Brent Longnecker, an executive compensation specialist, says, "To play in the high-tech sandbox, you must grant more stock options to everyone in the company, more so than in traditional sectors."

In the high-tech industry, it's not unusual for 20 percent of a pay package to be in options, compared with 10 percent in non-high tech fields. Moreover, options are offered much farther down the food chain than in other industries.

Usually, it's the top five to 10 executives in a company that can negotiate stock options, says Diane Lerner, a compensation consultant with human resources and benefits firm Watson Wyatt in New York. "For most employees, the stock-option grant is generally part of the compensation package, and not offered as a trade-off except at the top-10 level."

In the 1960s, stock options were very popular and considered a key form of compensation for executives. "Then a funny thing happened," remarks Longnecker. "From 1969 to 1973, the Dow froze up. Stock options lost a lot of their luster."

Longnecker notes that stock options are only appealing during a bull market. No one wants to get paid in shares experiencing price volatility or that have little value in the market.

It's important that you consider more than just the compensation package. Longnecker recommends ensuring you are able to live on the cash salary and to not rely on future money from stock options.

"Leaving a secure position just because you're offered stock options can lead to disappointment," says Longnecker. "There's always the chance that the IPO will never take off."

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