Overview
What is it:
A stock option is a form of equity compensation that offers you the right, but not the obligation, to purchase a set number of company shares at a fixed price established at grant (known as the strike price). That right only becomes usable once the option vests. Exercising the option means acquiring the actual shares (usually by paying the strike price) within a defined window of time after vesting, but before the option expiration date. Stock options also come in two main types, incentive stock options (ISOs) and non-qualified stock options (NQSOs), which are taxed differently.
Why does it matter:
Stock options exist because a company wants to reward growth specifically. An option only pays off once the stock price rises above the strike price. Granting options rather than RSUs signals the company is compensating you for the appreciation you help create.
What do people most often get wrong:
People often treat an option grant as equivalent in value to an RSU grant of the same size. An RSU has value as long as the stock price is above zero. An option only has value once the stock price rises above the strike price, and that gap, called the spread, is the actual source of an option's worth.