If we ignore tax considerations and assume that Sally Jameson is free to sell her stock options at any time after she joins Telstar she has several options.
She can either choose to take the cash bonus, the stock options and sell it, or she can take the option and keep it until it is worth use.
Let’s compare the three situations that we choose to analyse :
1- She takes the cash bonus and decide to invest it in a 5-year bond which has a anualize rate of 6.02%.
So at the end she will win 5310$ (=5000*1.0602).
2- She takes the options in order to sell her stock options.
Let’s assume that it is easy to find someone who want to buy the option at the value of the ...view middle of the document...
And even more if we want to stock to be more than 36,767 for example.
(Bob Marks agree with that)
The stock probably won’t go over 35$ so it is not worth keeping the option.
And since taking the options, sell it and then invest it (making her win 9301,7$) is better than taking the cash bonus and invest it in a 5-year bond, the option package worth more.
In this case, Sally Jameson can’t sell the options and has to pay taxes. So the selling option solution which was the better one in the first question is no longer available.
Now she has the choice between taking the cash bonus or using the options at the time of her fifth anniversary with the firm.
Let’s assume that Ordinary taxe rate is 28% and the capital gains taxe rate is 28%.
1- If she takes the cash bonus and she will get 5000*(1-0,28)=3600$.
If she invests in a 5year bond she will get 3600+(3600*0,602*0,72)= 3756,04$
2- If she takes the options, and decide to use it and sell her shares :
She should wait the value of the stock to be higher than X if she wants to win more than with the cash bonus.
(X-35)*3000*0,72=3756,04 => X= 36,74$
Like in the first question, it is very unlikely that the value of the stock reach 36,74$
So this time, Sally should take the cash bonus.
When a company gives stock option to its employees, the writer of the option is the company and the employee is the holder of the option.
So when the employee exercise the option, he pays the company the strike price of the option.
Then the company wins cash and creates new shares.
Given that the company sells to the owner of the option cheaper shares that the value of the underlying asset, we could say that the company loose money, or rather win less money (it could have won more money by selling the shares at the price market). In that way we could say that stock options have a cost.
This cost wouldn’t be « paid » by the company but by the shareholders.
* The holder of the stock option can avoid tax payments because tax on individual income is higher than tax on capital income