Okay, super technical concept and term, but one that has extreme compensation differentials, depending on who you are and, well, how sleazy you want to be.
First start with the notion that stock options are granted as compensation for key employees in early-stage companies, and also for very senior officers of public companies. When companies are private, usually the board of directors oversees the granting of options. They commit to the number granted, who gets them, and the strike price of those options, usually done as options on common stock (not preferred), and granted at the last valuation done on the company by some cadre of value-assessing lawyers and bankers who did something very bad in a former life to end up deserving this kind of career.
In a private company, there "are no rules" in the manner in which public companies have tons of rules. In a private company, the view is generally that they are owned by a relatively small handful of people, all of whom are big girls and boys and know how the game is played. So option strike prices get granted with most or all parties knowing wassup.
In public companies, the diff is big. That is, stock options strike prices usually have a formula behind them, i.e. "whatever the end of day closing price of the stock is on the day said options are granted shall be the strike price of the options granted to said employee." Ok, but what date were the options officially granted? When the employee nodded vaguely that she'd accept the job? Or on the last Friday of last month? Or when they signed on the dotted Hellosign?
So then what happens if a stock was at $18 a share last month and zoomed on the announcement of the potential hire of a rockstar CEO? And, in fact, an ethical situation did, happen and it was with AAPL and Jobs' option package as CEO. Overly simply, the company backdated the strike price of his options a month or two or three (what's a few months among friends?). Well, it was about $22 in value appreciation per share from back-then $69 to about $90 a share, where the company set his strike at the $69 figure insted of the date-signed-on-bottom-line date when his options were granted.
Investors sued. Apple demurred. They hired better lawyers. They cared more. And the whole mess was quietly papered over. Nothing like a winner stock that's making "everyone" money to make it easier for legal (or at least ethical) violations like options backdating to, um, just go away.
Related or Semi-related Video
Finance: What are stock options in 90 se...0 Views
Finance allah shmoop what are stock options in ninety seconds
or less Here's a stock ibm not the tech company
This one makes an anti constipation drug It's trading at
one hundred eighty bucks a share Okay so here's an
option of buy a share of ibm anytime in roughly
the next three months For one hundred ninety dollars a
share it's called a call option If you really believe
the ibm will go to say two hundred dollars a
share in the next three months well you'd be what's
called ten dollars in the money then or then have
a stock option or call option with a strike price
of one hundred ninety dollars which would then have intrinsic
value of ten bucks a share On the other end
of the buy sell desk is the gal willing to
sell you that call option for three bucks Three bucks
a premium So gut check time Would you pay three
dollars for the right to buy a share if ibm
for ten dollars higher than where the stock's trading now
today Meaning that to break even in the next three
months the stock has to trade all the way up
from one hundred eighty dollars a share to one hundred
ninety three dollars a share jobs for you to get
your money back but it goes to two hundred two
share Well if you sell that option you'll have invested
three bucks a share for a net return of seven
bucks in just three months or less And yes we're
ignoring commissions and taxes here because well in problems like
this or just a in the book but three dollars
into seven only three months Yeah that's a great score
You'd have more than doubled your money And on an
annualized return basis that's over a nine hundred percent dish
return really good score but with a much more likely
case that you spend three bucks to buy the option
and it expires totally worthless And then you've lost your
entire investment in that option So that's a call option
It's evil twin is a put option So whereas a
call options the rightto by a security to set price
by a certain set date a put option is the
right to sell that option We'd go into more detail
here but we're promised ninety seconds
Up Next
What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
The intrinsic value of an option is the share price of a stock minus its strike price - i.e. the "in the money" amount.