Stock Option Terminology

Stock Option: The right to purchase a share of stock for a specified price,for a specified period of time. Most options granted to employees give theemployee the right to buy the stock at the market price on the day the option isgranted. Most options also give that right to employees for a period–or “term”–often years.

Exercise Price: An option is a right to purchase a share of stock for aspecified price. That price is called the exercise price

Underwater Option: This is an option whose exercise price is higher than thecurrent market price of the stock. Options rarely start out underwater. Theystart out “at the money,” meaning that the exercise price is equal to themarket price. If the stock price drops below the exercise price after it isgranted, then the option is “underwater” and as such is not worth much.

In the Money Options: An option is “in the money” when the market priceis higher than the exercise price. This is good because you can exercise theoption, and buy the stock for less than you could sell it for in the stockmarket.

Restricted Shares: These are shares of stock that are granted to an employee.While they are officially owned by the employee (who gets dividends and can votethe shares), they have “restrictions” on them. The restrictions make it sothe share of stock may not be sold or transferred (given) to anyone else.Usually, the restricted shares vest over time. When the restricted shares vest,the restrictions lapse and the shares can then be sold if the employee wishes.If the employee leaves the company before the shares vest and the restrictionslapse, he of she loses all rights to the shares.

Future Grant: An award of options or restricted shares to be made in thefuture.

Option Dilution: When earnings per share is calculated, net income is dividedby the total number of outstanding shares of stock. When stock options aregranted, and especially when those options are “in the money,” the number ofshares used in calculating earnings per share is increased to reflect thepotential number of new shares that would be issued if all options wereexercised. This reduces or “dilutes” the earnings-per-share number.

Black-Scholes Option Pricing Model: This is a statistical formula developedin the early 1970s by Fischer Black and Myron-Scholes to estimate the marketvalue of a publicly traded stock option. This model and variations of the modelare used every day to determine trading prices.

Fair Market Value: The value of the stock or option if it were traded on theopen market.

Scheduled Option Grant: A company’s regular annual option grant to alleligible employees.

Value for Value Basis: This is where old, underwater options are traded in byemployees in exchange for new “at the money” options based on the relativevalue of the old versus new options.

Overhang: This is a percentage–the percentage of the company’s stock thatis devoted to options. The calculation is the number of options that have beengranted and are outstanding, plus the number of restricted shares granted andoutstanding, plus the number of shares reserved.

Workforce, January 2003, p. 52 — Subscribe Now!