Understanding Non-Qualified Stock Options (NSOs)

Learn why non-qualified stock options can be an important part of compensation.

A non-qualified stock option (NSO) is a type of equity compensation that gives an employee the right to purchase company stock at a predetermined price, known as the grant price (also referred to as the exercise price or strike price), after a specified vesting period. Once vested, the employee can exercise the option to buy the stock at the grant price, regardless of the current market value.

The difference between the market value and the grant price is called the spread or the in-the-money value. This spread represents the potential financial gain for the employee and is taxed as ordinary income at the time of exercise.

NSOs are subject to a vesting schedule set by the company, which determines when the options become exercisable. They also have an expiration date, typically 10 years from the grant date. However, if an employee leaves the company, the expiration period for vested options may be shortened, often to 90 days, which is a critical factor to consider when changing jobs.

Methods of Exercising NSOs

There are two primary ways employees can exercise NSOs:

  • Cash Exercise: The employee pays the grant price (plus any applicable taxes and fees) to purchase the shares. After exercising, they can choose to hold or sell the shares. This method requires the employee to have sufficient cash on hand.
  • Cashless Exercise: The employee exercises the options without needing upfront cash. A portion of the shares are sold immediately to cover the exercise cost, taxes, and fees, and the employee receives the remaining shares or cash. This method is helpful for those who don’t have liquid funds available.

If the employee holds the shares after exercising, whether through a cash or cashless method, any future gains upon sale may be subject to capital gains tax, depending on how long the shares are held post-exercise.

Important Considerations

  • Understanding the tax implications is essential for effective financial planning. Mistiming an exercise or sale could lead to unexpected tax liabilities or missed opportunities.

The information provided is for informational purposes only and not intended to provide investment, tax, or legal advice. Neither the information provided, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. All investing involves risk including possible loss of principal. Any investment strategies that are presented may not be suitable for all investors. Steward Partners, its affiliates, and its Wealth Managers, do not offer tax advice. We suggest discussing your specific situation with a financial and tax professional before making any decisions. Past performance is no guarantee of future results.

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