Stock Options

The right to purchase company shares at a fixed price, typically lower than market value, within a set window.

Stock options give employees the right — but not the obligation — to buy company shares at a predetermined price called the strike price. The strike price is typically set to the fair market value at the time of grant. If the company's share price rises above the strike price, the options are 'in the money' — exercising them lets you buy shares at a below-market price.

Options are most common at startups and early-stage companies as a way to offer potential upside in lieu of competitive cash compensation. If the company never appreciates beyond your strike price, your options expire worthless. Unlike RSUs, options require an active decision to exercise — and that decision has timing and tax implications.

Two main types exist. Incentive Stock Options (ISOs) receive potentially preferential tax treatment but are subject to Alternative Minimum Tax (AMT) at exercise. Non-Qualified Stock Options (NSOs) can be granted to employees and contractors, and the spread at exercise is taxed as ordinary income immediately.

Stock options are most common at pre-IPO companies. At public companies, RSUs have largely replaced options because they're simpler and always have value. If you're receiving options rather than RSUs, it's almost certainly at a private company — and the value depends heavily on the company's trajectory.

ISO vs. NSO: Key Differences

  • ISOs can only be granted to employees; NSOs can be granted to employees, contractors, advisors, and board members.
  • ISO exercise is not a regular income tax event — but it may trigger Alternative Minimum Tax (AMT) in the year of exercise.
  • If you hold ISO shares for at least 2 years from grant date AND 1 year from exercise date, any gain is taxed at long-term capital gains rates.
  • NSO exercise triggers ordinary income tax on the spread immediately — whether you sell the shares or not.
  • There is an annual ISO limit: no more than $100,000 in options can vest as ISOs in a single calendar year; amounts above this convert to NSO treatment.

How to Value Your Stock Options

Valuing private company stock options is genuinely difficult. The company's most recent 409A valuation sets the fair market value for your strike price, but this isn't the same as what your shares are actually worth in a sale — the 409A values common stock, while investors hold preferred stock with liquidation preferences that get paid out first. A company valued at $500M might not return anything to common stockholders if the investors' preferences exceed the acquisition price. Ask: what is the preference stack, and at what acquisition price do common shares start participating?

The 83(b) Election: What It Is and When to File

When you exercise options early (before vesting), you can file an 83(b) election with the IRS within 30 days to pay tax on the current FMV rather than the higher value at vesting. This is powerful when the 409A is very low — you pay minimal tax now and any future appreciation is taxed at capital gains rates. Miss the 30-day window and you lose the election permanently.

  • Must be filed within 30 days of the option exercise — no exceptions, no extensions.
  • Most beneficial when exercised at grant when FMV is very low (at or near strike price).
  • Requires sending a physical letter to the IRS and keeping a copy — document the filing carefully.
  • Talk to a tax advisor before filing — the math depends on your specific situation and the company's stage.
  • Not worth filing if the exercise price is already well below current FMV.

What Happens to Your Options When You Leave

When you leave a company, unvested options are forfeited immediately. For vested options, you typically have 90 days from your departure date to decide whether to exercise. Exercising requires real cash outlay (the strike price × number of shares), plus ordinary income tax on the spread for NSOs. If the company is private, the shares are immediately illiquid. Some companies offer extended exercise windows (up to 10 years), which is a meaningful benefit worth asking about during an offer negotiation.

Example

An engineer joins a Series B startup with 50,000 ISOs at a $2.00 strike price. Four years later the company raises a Series D at a $20.00 preferred share price. His spread is $18 per share — but exercising all 50,000 costs $100,000 and triggers AMT exposure. He exercises 20,000 shares in a year he can absorb the tax liability, files an AMT calculation with his accountant, and holds the rest until a liquidity event rather than letting all options expire unexercised.