Q: I've just taken a job with a company that includes stock options as part of the benefits package. I know this isn't the same as getting "stock" itself, but can you explain how stock options work and when I can expect to make any money off them?
A: Stock options started to gain popularity in the late 1980s and exploded with the dot-com boom of the 1990s. Although options are still often associated with the high-tech world, all sorts of industries offer them to employees. Companies see options as a tool to motivate and reward workers. With them, workers have a strong incentive to work toward their employer's profitability.
Basically, your stock options allow you the right to buy your employer's stock at a fixed price when the stock is trading at a higher price on the market. That fixed price, called the "grant price," is probably what your company's stock was trading at on your first day of work. So, let's say your company gave you 100 options at the grant price of $20 per share. Suppose the stock is trading at $60 per share five years from now, and you choose to "exercise" your options. You will buy $2,000 worth of company stock, stock that is actually worth $6,000 on the market. You can hold the stock or turn around and sell it, pocketing the $4,000 difference.
This example is simplified, and you should look into the details of your company's plan. Pay attention to the "vest date," which is the earliest date you can exercise your options. A "vesting schedule" will stagger the percentage of your options you may exercise over the years until their expiration date, typically 10 years after the options were first granted.
What happens if your company offered you a $20 grant price, and in five years the stock falls to $5? The options are said to be "underwater." Obviously, there's no point in exercising them until the stock price surpasses the grant price. For the time being, the options are worthless. Sometimes, a company may reprice options to retain unhappy employees, but there's no guarantee of it.
For that reason, and because depending on the performance of a single stock is risky, it's best to think of your options as a type of bonus instead of a core component of your salary. You should still contribute to your 401(k), and develop a diversified investment portfolio with your options forming only a portion of your holdings.
Jean Chatzky’s Bottom Line:
This week: Are you completely insured?Your homeowner’s policy covers many items, such as the structure of your home, personal belongings, and liability (for example, if someone falls on the stairs in your home). But it may not cover the cost of your wedding ring or your engagement ring. In fact, the typical homeowner’s policy only insures such jewelry for up to $1,000 in the case of theft or loss. If you're not covered, you'll want to increase your insurance or buy a rider to make sure your valuables are protected. Here are a few other high-end items that may need additional insurance:
• Computers• Artwork • Cameras • Furs • Antiques
Jean Chatzky is the financial editor for “Today,” editor-at-large at Money magazine and the author of “Talking Money: Everything You Need to Know About Your Finances and Your Future.” Copyright © 2004. For more information, go to her Web site, .