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Employee Stock Options: What They Are, How They Work
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Employee Stock Options: What They Are, How They Work
Employee stock options may offer an opportunity to participate in the stock market success of your company.
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Taryn Phaneuf is a lead writer & content strategist covering wealth management, financial planning and other investing topics at NerdWallet. She previously reported on personal finance news. Prior to joining NerdWallet, she spent more than a decade covering education, public policy and business for various news outlets. She also taught journalism as an adjunct instructor at her alma mater, the University of Minnesota.She lives in Minnesota.
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23 years of experience Expertise Taxes Small business Social Security and estate planning Home services RIATina Orem is an editor and content strategist at NerdWallet. Prior to becoming an editor and content strategist, she covered small business and taxes at NerdWallet. She has a degree in finance, as well as a master's degree in journalism and an MBA. Previously, she was a financial analyst and director of finance at public and private companies. Tina's work has appeared in a variety of local and national media outlets.
Tina Orem is an editor and content strategist at NerdWallet. Prior to becoming an editor and content strategist, she covered small business and taxes at NerdWallet. She has a degree in finance, as well as a master's degree in journalism and an MBA. Previously, she was a financial analyst and director of finance at public and private companies. Tina's work has appeared in a variety of local and national media outlets. Published in Editor & Content Strategist + more + moreWhat are employee stock options?
What are employee stock options?Employee stock options are a common form of equity compensation that give employees the option to buy a certain amount of company stock at a pre-set price
Employee stock options are a common form of equity compensation that give employees the option to buy a certain amount of company stock at a pre-set price Code of Federal Regulations. 26 CFR § 1.422-2. Accessed Sep 2, 2025. . If you choose to exercise stock options when the pre-set price (known as the strike price or exercise price) is below the stock’s fair market value, you’re buying it at a discount. You may reap substantial rewards with stock options if your company’s share price increases, but it's not guaranteed and there are taxes to consider. ? Nerdy TipEmployee stock options aren’t the same as exchange-traded stock options. Learn more about options.
Employee stock options aren’t the same as exchange-traded stock options. Learn more about options .Pros and cons of employee stock options
Pros and cons of employee stock optionsMany employers offer stock options as a way to align employee interests with company interests and to attract and retain talent. They can be a meaningful component of a job offer or promotion compensation package, so it's important to understand and evaluate how their current and potential value fit with your financial goals. (You can use our total compensation calculator to see what stock options add to the value of a job offer.)
Many employers offer stock options as a way to align employee interests with company interests and to attract and retain talent. They can be a meaningful component of a job offer or promotion compensation package, so it's important to understand and evaluate how their current and potential value fit with your financial goals. (You can use our total compensation calculator to see what stock options add to the value of a job offer.) ProsPotential financial reward may be substantial.
May have minimal tax liability.
ConsMay require out-of-pocket costs to exercise your options.
Value depends on whether the strike price is lower than the market price.
Tax advantages vary by type and can be complicated to navigate.
They expire.
How employee stock options work
How employee stock options workEmployee stock options have five key stages. Here’s what to know about each.
Employee stock options have five key stages. Here’s what to know about each.The grant date is the date on which your employer awards you the stock options. At this point, you’ll get information about the number of shares you will have the right (but not the obligation) to buy, the strike price, when the options vest and when they expire.
The grant date The grant date is the date on which your employer awards you the stock options. At this point, you’ll get information about the number of shares you will have the right (but not the obligation) to buy, the strike price, when the options vest and when they expire.The vesting period is a waiting period between the grant date and when you’re allowed to exercise the options. It may be months or years long. Your company might allow you to exercise employee stock options early (before they vest). This is sometimes referred to as an 83(b) election, and it can have some tax advantages. If you leave the company before your options have vested, you may forfeit the right to exercise them.
The vesting period The vesting period is a waiting period between the grant date and when you’re allowed to exercise the options. It may be months or years long. Your company might allow you to exercise employee stock options early (before they vest). This is sometimes referred to as an 83(b) election , and it can have some tax advantages. If you leave the company before your options have vested, you may forfeit the right to exercise them.The exercise date is the date on which you purchase company shares. It usually makes the most sense to exercise stock options when the strike price is below the fair market value of the company’s stock, but there are other considerations as well. Depending on the type of stock options you have, you may owe taxes when you exercise your options.
The exercise date The exercise date is the date on which you purchase company shares. It usually makes the most sense to exercise stock options when the strike price is below the fair market value of the company’s stock, but there are other considerations as well. Depending on the type of stock options you have, you may owe taxes when you exercise your options.The sale date is the date on which you sell the shares you acquired by exercising your options. Selling your shares for more than you paid for them may create a taxable event. More on that below.
The sale date The sale date is the date on which you sell the shares you acquired by exercising your options. Selling your shares for more than you paid for them may create a taxable event. More on that below.The expiration date is the date on which your options expire, meaning they’re no longer exerciseable. Options typically expire up to 10 years after the grant date.
The expiration date The expiration date is the date on which your options expire, meaning they’re no longer exerciseable. Options typically expire up to 10 years after the grant date.Employee stock options can be complicated, and it takes effort to navigate them strategically. If you’re not comfortable doing it on your own — or even if you are — it may be worthwhile to find a financial advisor who understands equity compensation and can help you evaluate all the factors of your specific situation.
Employee stock options can be complicated, and it takes effort to navigate them strategically. If you’re not comfortable doing it on your own — or even if you are — it may be worthwhile to find a financial advisor who understands equity compensation and can help you evaluate all the factors of your specific situation.» MORE: How restricted stock units (RSUs) work
» MORE: » MORE: How restricted stock units (RSUs) workTypes of employee stock options
Types of employee stock optionsThere are two main types of employee stock options.
There are two main types of employee stock options.Incentive stock options, or ISOs, are only issued to employees and can receive preferential tax treatment. However, they can lose some or all of their favorable tax treatment if their value exceeds $100,000
Incentive stock options , or ISOs, are only issued to employees and can receive preferential tax treatment. However, they can lose some or all of their favorable tax treatment if their value exceeds $100,000 IRS.gov. Equity (stock)-based compensation audit technique guide. Accessed Sep 2, 2025. .Nonqualified stock options, or NSOs, are options companies grant to employees, as well as outside service providers, consultants or advisors. NSOs tend to have more flexibility but are taxed less favorably.
Nonqualified stock options , or NSOs, are options companies grant to employees, as well as outside service providers, consultants or advisors. NSOs tend to have more flexibility but are taxed less favorably.» Ask an advisor: Which is better, RSUs or stock options?
» Ask an advisor: » Ask an advisor: Which is better, RSUs or stock options?NSOs
NSOs
NSOsISOs
ISOs
ISOsEligibility
EligibilityEmployees, plus outside service providers, such as advisors, board directors, other consultants.
Employees, plus outside service providers, such as advisors, board directors, other consultants.Employees only.
Employees only.Tax treatment
Tax treatmentNo preferential tax treatment. You may owe:
No preferential tax treatment. You may owe:Ordinary income tax upon exercising.
Ordinary income tax upon exercising.Capital gains tax upon sale.
Capital gains tax upon sale.Preferential tax treatment. That means:
Preferential tax treatment. That means:Income taxes are deferred upon exercising. (Though you may owe alternative minimum tax.)
Income taxes are deferred upon exercising. (Though you may owe alternative minimum tax.)If holding requirements are met, you may owe only long-term capital gains tax upon sale.
If holding requirements are met, you may owe only long-term capital gains tax upon sale.Limits
LimitsNone.
None.ISOs lose some or all of their preferential tax treatment if the value of the underlying shares exceeds $100,000 per year.
ISOs lose some or all of their preferential tax treatment if the value of the underlying shares exceeds $100,000 per year.What happens to your employee stock options if you leave your job?
What happens to your employee stock options if you leave your job?If you leave your job, the fate of your employee stock options largely depends on whether they’ve vested. Be sure to review your stock options agreement to get the specific details on what happens to your options if you retire, get fired or otherwise leave the company.
If you leave your job, the fate of your employee stock options largely depends on whether they’ve vested. Be sure to review your stock options agreement to get the specific details on what happens to your options if you retire, get fired or otherwise leave the company.Unvested options: You’ll probably lose any options that haven’t vested, though there are exceptions.
Unvested options: Unvested options: You’ll probably lose any options that haven’t vested, though there are exceptions.Vested options: You’ll typically maintain the right to exercise stock options if those options have vested. However, you may be required to exercise those options in a timely manner, such as within 90 days of leaving the company.
Vested options: Vested options: You’ll typically maintain the right to exercise stock options if those options have vested. However, you may be required to exercise those options in a timely manner, such as within 90 days of leaving the company.» Dive deeper: How stock option taxes work
» Dive deeper: » Dive deeper: » Dive deeper: How stock option taxes workON THIS PAGE
What are employee stock options? What are employee stock options? Pros and cons of employee stock options Pros and cons of employee stock options How employee stock options work How employee stock options work Types of employee stock options Types of employee stock options What happens to your employee stock options if you leave your job? What happens to your employee stock options if you leave your job?ON THIS PAGE
What are employee stock options? What are employee stock options? Pros and cons of employee stock options Pros and cons of employee stock options How employee stock options work How employee stock options work Types of employee stock options Types of employee stock options What happens to your employee stock options if you leave your job? What happens to your employee stock options if you leave your job? More like this Investment Basics Investing How Much Does a Financial Advisor Cost? Most financial advisors charge based on how much money they manage for you. Fees are typically 1% a year but can be lower. 2 By Andrea Coombes, Taryn Phaneuf Do You Need a Financial Advisor? 7 Ways to Tell You may need a financial advisor if you're facing big life changes, don't have financial goals, have complex compensation, high tax bills or for other reasons. Taryn Phaneuf How to Find Cheap or Free Financial Advice Quality financial advice is more accessible than ever — and much of it is free or inexpensive. Here's how to get it. Anna-Louise Jackson 3 Steps to Prepare for Your First Financial Advisor Meeting Here's what think about and bring to your first meeting with a financial advisor. June ShamGet matched to a financial advisor for free with NerdWallet Advisors Match.
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