Stock options: NQSOs and ISOs

Stock Options: What Are They?

Stock Options: What Are They?

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Upbeat music plays throughout.

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Onscreen text:
Stock options: What are they? 

An animated scene inside an airport terminal. Outside, visible through a window, an airplane taxies in from the right while a woman walks into the scene from the left, rolling her suitcase. 

Female narrator: Investing is a journey. And stock options can be an important part of that journey that can help you get where you want to be.

The woman continues walking through the airport terminal, passing other travelers who are looking out a window at the plane rolling by. 

Narrator: They're a way to share in your company's success. Because when the company does well, so do your stock options.

The woman steps onto an escalator going up, passing posters on the wall along the way. 

Narrator: It's important to know that stock options aren't actually stock.

Onscreen text on the first poster:
The option to buy shares of your company's stock at a specified price—called the award price

Narrator: They're the option to buy shares of your company's stock at a specified price—called the award price.

The woman studies the next poster and rests her chin in her hand, considering what she has just read.

Onscreen text on the second poster:
The fixed price you'll pay for your shares

Narrator: No matter how much the stock price in the market might increase, you can still buy shares at your award price.

You earn your stock options over time, through a process called vesting.

Onscreen text on the third poster:
This means earning your stock options over time.

Narrator: Once your options are vested, you have choices to make about when and how to exercise them.

As the woman passes the VESTING poster, she nods as if in agreement.

Onscreen text on the final poster:
Purchasing your options of company stock—before they expire

The woman studies this final poster. She arrives at the top of the escalator and continues walking through the terminal.

Narrator: Exercising options means purchasing shares of your company stock. And you'll really want a plan for what you'll do with them before you exercise.

The woman passes others in the terminal. Then she pauses and moves her hand to her chin as if in thought. Three circles representing thought bubbles pop up above her head. The one on the left is navy with a bar graph; the one in the center is light blue with a calendar icon; and the one on the right is red with three dollar bills. The three circles then animate and merge together under the red circle featuring the money. The word "HOLD" appears on a monitor mounted near the windows.

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Narrator: When making that decision, it's important to consider the value of the stock price, when your options expire, and your personal or financial tax situation.

The red circle animates to show an icon of a certificate, and the woman starts walking again.

Narrator: It also helps to think about what you want out of your exercise after it settles. Do you want cash to spend? Or would you rather have company stock?

There are three common ways to exercise: hold, sell, and sell-to-cover.

The woman resumes walking, and next to the monitor saying "HOLD," two other monitors come into view. The two new monitors say "SELL" and "SELL-TO-COVER," respectively. The woman stops and looks up at the monitors.

The frame zooms in on the monitor that says "HOLD."

Narrator: "Hold" means buying your shares and keeping all of them. 

The word "HOLD" fades away and is replaced by a blue screen that has an icon of a stock certificated on the left. 

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If the market price dips below your award price, your shares will lose value.

Narrator: This gives your shares time to potentially gain value. But it can also be risky because there's no guarantee you'll make a profit. If, for example, the market price of the stock dips below your award price, your shares will lose value.

A dollar bill icon in a circle emerges from the stock certificate icon and moves up and down across the screen, mimicking the rise and fall of stock values.

The frame moves to the monitor containing the word "SELL" and zooms in. 

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Money from sale of stock – Taxes = Your profit

A circle appears on the screen and a total of five dollar bills appear in it, one at a time.

Narrator: "Sell" means you exercise your options and immediately sell the purchased shares for cash. The money from the sale is yours after taxes, and you could use it to pay for a short-term financial goal or reinvest it, amongst other things.

The frame moves to the sign that says "Sell-to-cover" and zooms in. A circle appears that fills with three stock certificate icons.

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SELL-TO-COVER (Partial Sell)
Exercise stop options [then] Sell just enough shares to cover price and taxes [then] Own shares without spending cash

Narrator: "Sell-to-cover" means you exercise your stock options, then immediately sell just enough of the shares you just bought to cover the price and taxes. In the end, you're left with shares you own that you didn't have to dip into your savings to buy.

Zooms out to show the woman looking up at all three monitors. In the background, an airplane takes off from the left [Rumble of the jet engines] and ascends to the right.

Narrator: And before you make any exercise decisions, think about your financial goals and how your stock options can help you reach them.

The screen split into two frames. On the left, the woman resumes walking through the terminal. On the right, a beach scene appears, featuring a white Adirondack chair and a tropical drink under a sunny sky.

Narrator: Do you need to build up a retirement savings fund?

The woman continues walking in the left screen, while the right screen transitions to a laptop computer surrounded by a lamp, coffee mug, pencil holder and eyeglasses. On the computer screen is a circle graph divided into sections of various colors and with a dollar sign in the center.

Narrator: Diversify your investments to potentially grow wealth?

The right side of the screen then transitions to a young girl and a dog standing in front a house with a "For Sale" sign in the yard. The woman walks from the airport terminal in the left screen into the yard and joins the girl and the dog. The left screen disappears as a "Sold" sign covers the "For Sale" sign and the woman puts her arm around the girl. The dog wags its tail and barks.

Narrator: Or save for a home? 

When you're ready to make your move, log in to the Equity Award Center to exercise your options.

A white screen fills and gray text appears.

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Still have questions?
Call a Schwab Stock Plan Specialist at 800-654-2593.
International Participants, call +1-602-355-3408.

Narrator: Still have questions? Give us a call.

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Schwab Stock Plan Services provides equity plan services and other financial services to corporations and employees through Charles Schwab & Co., Inc. ("Schwab"). Schwab, a registered broker-dealer, offers brokerage and custody services to its customers.

©2023 Charles Schwab & Co., Inc. All rights reserved. Member SIPC. CC7077878 (0123-2HAB)



Stock options

With stock options, you have the opportunity—but not the obligation—to buy company stock at a fixed price (known as the "award price"). Stock options are subject to a vesting schedule. The vesting schedule establishes the length of time you will need to be employed at your company before the ownership of the stock options shifts to you. Once vested, stock options will have value only if the current stock price is higher than the award price.

Understanding your grant agreement

The grant agreement you receive from your employer covers important details about your stock options, including:

  • Your grant date. The grant date is when you've officially been granted your options. This is important as it sets your vesting schedule and exercise periods (see below).
  • The number of stock options and the type you have been granted. There are two main types of stock options: non-qualified stock options (NQSOs) and incentive stock options (ISOs).
  • The award price for the grant. The award price is the fixed amount you'll pay for each share of stock (regardless of the stock price on the open market). An award price can also be referred to as a strike price, exercise price, option price, or grant price.
  • The vesting schedule. A vesting schedule establishes the time frame in which stock options become available for you to purchase (which is called "exercising").
  • The exercise period. This is the amount of time you have to exercise your options once they vest. In most cases, you'll have 10 years from the date of grant before your options expire.

Make sure to read and understand your full grant agreement. There are additional details about transferability, taxation, and more.

How to exercise your options

Exercising means using your options to buy shares of company stock at the award price. Let's say you have 2,000 options with an award price of $40 and the current stock market price is $50. The value lies in the difference between the award price and market price (known as the spread). Your potential profit is $20,000 (the $10 spread times 2,000 options)—and you commonly have three choices for what to do next:

  1. Exercise and hold: You buy the stock and hold it. The entire amount is subject to changes in market value.
  2. Exercise and sell: You buy the stock and immediately sell it. This is known as a cashless exercise, as no money is required out of pocket.
  3. Sell to cover: You buy the stock and sell just enough to cover the cost of the purchase price, plus applicable taxes and transaction costs. In other words, instead of getting a profit in cash, you get it in stock.

Prior to exercising or selling any shares, you'll want to carefully consider any applicable fees and the tax consequences. For advice, consult a tax advisor or a financial consultant.

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How stock options are typically taxed: NQSOs vs. ISOs

Employees are generally granted one of two types of options—non-qualified stock options (NQSOs) or incentive stock options (ISOs)—and the main difference lies in how the spread is taxed.


  • The spread is taxed as ordinary income in the year in which you exercise the options—even when you hold on to the shares—and companies usually withhold some of the proceeds to help pay applicable Medicare, Social Security, and other taxes.


  • You are not subject to ordinary income tax when you exercise your options, but the spread is taxed when you sell your shares.
  • If you hold the shares for more than one year past the exercise date and more than two years past the original grant date, the sale of the stock becomes a qualifying disposition, and any realized profit is typically taxed at the long-term capital gains rate.
  • If you sell earlier, the spread will be taxed at your ordinary income tax rate.

On the surface, ISOs might seem like they offer more favorable tax treatment than NQSOs, but they come with a hidden risk: The spread when you exercised the option will count as taxable income when calculating the alternative minimum tax (AMT) in the year you exercise your options, which could result in a larger overall income tax liability. Calculating your AMT is tricky, so be sure to consult an accountant or tax advisor before exercising your ISOs.

Note: This section refers to U.S. taxation. International tax filers may have different obligations. Learn how taxation works in your country with our Global Tax Guide, which you can access while logged into the Equity Award Center.

Cost basis and tax forms

When filing your taxes, it's important to be mindful of the cost basis you report. Cost basis is the original purchase price you paid for shares (plus commissions, fees, and any transaction costs), but note that stock options are treated differently. In addition to the purchase price, the cost basis on NQSOs needs to be adjusted to include the spread. If you exercised your ISOs, you may need to keep track of more than one cost basis: one for ordinary income and another for AMT. 

Using the correct cost basis ensures that you file correctly and aren't taxed more than the required amount. Refer to this cost basis sheet to help you determine the cost basis on your stock plan transactions so you can file your taxes accurately.

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Tax forms

Those who have exercised stock options will receive IRS Form 1099-B (U.S. only).

Those who were granted ISOs will also receive the IRS Form 3291 (U.S. only).

Common questions about stock options


What does it mean when stock options are "in the money" vs. "out of the money?"

When the current market price is higher than the award price your employer put in the grant agreement, your options are considered "in the money." If you were to buy the stock and then sell it on the open market, you would make an immediate profit.

When the market price dips below the award price, however, the stock options are "out of the money" or "underwater." In this situation, the stock options have no value, as it would cost you more to exercise your options than to buy them on the open market. Your Schwab One® brokerage account will automatically recognize if your stock options are out of the money and prohibit you from exercising them.


Can I transfer my stock options to another person?

Generally, no. Stock options typically are non-transferrable, with the exceptions of your passing or a court order related to divorce. Refer to your stock option agreement for details about transfers.


What happens to my stock options if my employment ends?

Under most circumstances, a grace period provides the opportunity to exercise vested stock options after your termination date. A common grace period is three months, but it's determined by the terms of each grant. The reason for employment termination is also a factor. In some cases, there is no grace period and rights expire immediately.


What happens to my stock options if I die?

Generally, your heirs or the executors of your estate will have one year from the date of your passing to exercise your vested but unexercised options. Refer to your award agreement(s) for details. Remember to include your stock options and other equity awards in estate planning; if your company permits you to elect a beneficiary, consider doing so.


How do I know if I have stock options?

Your company will notify you when you receive stock options. Grant details are also located in the Equity Award Center. Log in to your Schwab account. From the Summary page under Accounts, scroll down to Employer Sponsored Equity Awards. If you have stock options, you will see a summary of those awards in this section.

Have more questions about your stock options? We're available 24 hours a day, Monday through Friday.

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