Exercise price: Overview, definition and example
What is exercise price?
The exercise price, also known as the strike price, is the price at which an option holder can buy (in the case of a call option) or sell (in the case of a put option) the underlying asset, such as company stock. In the context of stock options, the exercise price is agreed upon when the option is granted, and it determines how much the option holder will pay to exercise the option in the future.
Why is exercise price important?
The exercise price is important because it sets the terms for how an option holder can profit from exercising their options. If the market price of the underlying asset is higher than the exercise price, the holder can buy at a lower price and potentially sell for a profit. Conversely, if the market price is lower than the exercise price, the option may not be exercised, as it would not be profitable.
For companies, the exercise price is also crucial when issuing employee stock options. It influences how attractive the option is to the employee, especially in terms of potential financial gain.
Understanding exercise price through an example
Imagine an employee, Jane, is granted stock options as part of her compensation. The exercise price of the options is set at $10 per share, meaning Jane can purchase company stock for $10 a share in the future. If the company's stock price rises to $20 a share, Jane can exercise her option to buy the stock at $10 and potentially sell it at the market price of $20, making a $10 profit per share.
On the other hand, if the stock price drops to $5 a share, Jane may choose not to exercise her option, as it would not make sense to buy the stock for $10 when it's available for $5 on the open market.
Example of an exercise price clause
Here’s how an exercise price clause might look in an option agreement:
“The Exercise Price of the options granted under this Agreement shall be $10 per share. The options may be exercised at any time after the vesting period and before the expiration date, subject to the terms of this Agreement.”
Conclusion
The exercise price is a fundamental component of options agreements, influencing both the attractiveness and profitability of the option. For option holders, it determines the potential for financial gain, while for companies, it plays a key role in employee compensation plans. Understanding the exercise price and how it works helps both parties make informed decisions when engaging with options.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.