What is an incentive-based stock option?
ISOs are offered after certain hourly or performance requirements are met
An incentive-based stock option, or employee stock option, is a kind of benefit that allows employees to buy shares of the companies they work for at discounted prices known as "exercise" prices.
Amazon, for example, previously offered stock options and incentive-based bonuses to employees before it raised its minimum wage to $15 an hour. The options guaranteed employees part of Amazon's stock when individual shares were valued at more than $1,950.
Tesla founder Elon Musk recently earned his first performance-based ISO from the electric automaker that allowed him to purchased about 1.7 million shares of Tesla's stock at an exercise price of $350 when shares were valued at $805, making the total buyout value a whopping $775 million.
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"As of the date of this proxy statement, one of the 12 tranches under this award has vested and become exercisable, subject to Mr. Musk’s payment of the exercise price of $350.02 per share and the minimum five-year holding period generally applicable to any shares he acquires upon exercise," an SEC filing read.
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In a more general example, an employer might offer its workers the ability to purchases 1,000 shares of its stock for $100 a share once vesting requirements, which often come in the form of hours or days worked, are met.
Employees may then only be able to purchase a specific amount of shares for a certain time period. For example, employees may be able to purchase and sell 250 shares of the stock every year, in which case it would take the employee four years to be able to purchase all 1,000 shares at the exercise price.
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Workers also may choose to wait to sell their shares until their value increases, which opens the opportunity to make a profit off the company's ISOs. These stock options have the potential to benefit both employers and employees, but there are always risks involved.
Startup companies often offer ISOs as a way to make money and pay employees, but startups also have more potential to fail, and their stock options may never surpass the exercise price.
ISOs also have tax consequences that can make returns more complex. Different employee stock options are taxed in different ways.
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ISOs are also generally only awarded to high-level management or employees who have been recognized for reaching certain achievements, according to the investment information website Investopedia.