Employee Stock Options: ISOs and NSOs

In general, a stock option is a financial instrument giving an employee the right to purchase shares in his or her own company, under conditions set by the employer. Some companies offer stock options

as a means of letting their employees take a vested interest in the business while reaping the rewards of its success. Two common plans are incentive stock options (ISOs) and nonstatutory stock options (NSOs), also known as nonqualified stock options.

The key difference between these two types of stock options is the way in which they are taxed: ISOs are mainly taxed under long-term capital gains and its inherent advantages, whereas NSOs are taxed as both income and capital gains.

Ideally, the company you work for awards you the option to buy company stock sometime in the future at the price that it is currently selling. This current price is called the exercise price. The exercise price set in the option is usually the market price of the stock at the time the option is granted. The assumption is that the company will be successful and the price will go up in the future.