I am pretty new to this & was trying to understand how do stock options work. For eg if a startup is offering 10k options for first year at a strike price of 5$, then how will they be exercised? Do I need to pay 10k*5$ to exercise options ? Or is it a cashless exercise at some startups? Also, if we have to buy options, how does it work?
The strike price (baseball term) means you can buy at that price up to three times before you’re “out” (fired). Options can be converted to stock by purchasing at the strike price. The stock can either be alive (livestock) or dead (deadstock). If you decide to hold (milk) the options, they are livestock. If you sell (slaughter) your converted options, you get deadstock and can cash that in for a bonus.
Ohh, is it always possible to sell the options after they have vested?
Once they’re converted to livestock, you can sell them if they are earmarked. For this to happen, they have to be branded and deemed eligible for “slaughter” by the Corp, called abattoir-ready (old French term) for short. Rules are different at each company, so ask accounting what the rules are for guiding your livestock to the abattoir.
I thought you were trolling initially with those livestock puns...
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Usually, it means you can buy the shares at $5 each when it become liquid, either when someone acquire the company or IPO. The actual price can be higher or lower than that. If it is higher you make money when you exercise and the difference is deposit into your account, if it is lower you cannot exercise because it will be a lost, it is also called under water. This is also why some call options from startup paper money or monopoly money, because of the high chance of it end up under water.
Okay. And is there no liquiduty options other than IPO or acquisition . For eg option buy back but the company itself?
If you are lucky a secondary investor may buy from you for a slight discount for RSU, but I haven't heard about it for options.