When given employee stock options in a private or public company, your Exercise Price or Strike Price is the price at which you have the option to purchase a given number of shares. The exercise price is determined by the Fair Market Value (FMV) at the time the options are granted.
Why Do I Need to Know My Exercise (Strike) Price?
Your exercise (strike) price is an important piece of information about your employee stock options for 2 primary reasons.
Exercise and Taxes
First of all, your exercise price is used to compute the dollar amount required to exercise, as well as the tax implications of your options. To exercise you must pay the strike price times the number of vested options you wish to exercise in exchange for your shares. Taxes are then calculated based on the spread between the current Fair Market Value (FMV) of the stock and your strike price. Taxes are calculated differently depending on which type of Employee Stock Options you have been granted.
Value of Your Options
Next, your exercise price sets the floor where you are in the money. Basically if the current price of the stock is greater than your exercise price, your options have positive value. If the current price is less than your exercise price, your options are considered under-water. In terms of the stock market, your exercise price is the price you bought the stock at, you hopefully will be able to sell the stock for a much higher price in the future.
Stock Options are tough to value given their illiquid and uncertain nature, however we at ESO attempt to place value on these options here.
You have 100,000 vested options at Company X with a strike price of $1.
The current FMV of Company X stock is $3.
In order to exercise, you will need to pay $100,000 (100,000 shares x $1 per share).
Your taxable gain at exercise will be $200,000 (100,000 shares x $2 or $3 - $1). **Remember this gain will be taxed differently depending on what type of options you were granted.
In the future if Company X goes through an IPO or M&A event, you will be able to sell your shares hopefully for an even higher price.