Companies are increasingly turning to employee stock options plans (ESOPs) to attract, retain and compensate employees. An ESOP is a contract between an employer and employee that gives the employee the right, but not the obligation, to buy or sell a particular number of shares of the company's stock at a fixed price, known as a strike price, within a specified time period. Employers will generally provide employees with information on how to protect the company's stock options plans.
Stock Options Basics
Stock options come in two basic types: puts and calls. Call options give the holder the right to buy the underlying stock at the strike price, while put options give the holder the right to sell the underlying stock at the agreed upon strike price. A holder is exercising her option when she decides to buy or sell the shares of underlying stock. Options contracts come with an expiration date, after which the right to exercise expires and the stock options become worthless. The contract multiplier states the number of shares to be delivered to or purchased from the holder when the option is exercised. Stock options contracts are for 100 shares per contract. Ideally, employees realize a profit when they exercise their option to sell their shares at a higher price than the strike price.
Employers who provide their employees with stock options plans have an obligation to present detailed information to employees regarding options contracts. Employees may have legal recourse if their employer failed to inform them about the risks involved. Employers have a responsibility to make sure employees have a clear understanding of the company's current financial position, and its future prospects in an unbiased and honest fashion. The employer must also make sure employees understand the possible tax consequences of exercising their options. Finally, employees should be told how to protect their investment with strategies like purchasing protective puts.
It is unlawful for an employer to restrict employees from buying protective puts to protect a company's stock options plans. If you exercise your option to buy shares in your company's stock, you can simultaneously purchase protective puts, which guarantee you the right to sell your shares at the strike price any time prior to the expiration date, no matter how much the market price of the stock drops. Essentially, protective puts are a form of investment insurance that entails buying one protective put contract for every 100 shares of company stock you already own. However, you will have to pay a premium for this protection.
Protective puts are a useful strategy for stock options holders with a bullish outlook for the value of the underlying stock. If you think the stock will increase in value, protective puts can guard your unrealized profits. The maximum profit potential on protective puts is unlimited, as long as the market price of the stock continues to climb. The protective put also gives you complete control of the sale of your protected shares.
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