Legal Definitions - stock-option contract

A stock-option contract is a legally binding agreement that grants one party the right, but not the obligation, to buy or sell a specific number of shares of a company's stock at a predetermined price (known as the "strike price") on or before a particular date (the "expiration date"). This contract allows the holder to potentially profit from changes in the stock's market price without immediately owning the shares.

• Example 1: Employee Compensation

  Maria works as a software engineer for "InnovateTech Solutions," a growing technology company. As part of her annual compensation package, she is granted 500 stock options. Each option gives her the right to purchase one share of InnovateTech Solutions stock at a strike price of $75 per share, anytime within the next seven years.

  This scenario illustrates a stock-option contract because it provides Maria with the right (but not the obligation) to buy a specific quantity of shares (500) of InnovateTech Solutions stock at a fixed price ($75) within a defined timeframe (seven years). If InnovateTech's stock price rises above $75 during that period, Maria can "exercise" her options, buy the shares at the lower strike price, and potentially sell them for a profit or hold them as an investment. If the stock price remains below $75, she can simply choose not to exercise, and the options will expire without her incurring any loss beyond the opportunity cost.

• Example 2: Investor Speculation

  An investor named Alex believes that the stock price of "Global Pharma Inc." (GPI) is likely to increase significantly in the coming months due to a promising new drug trial. Instead of buying GPI shares directly, Alex purchases a "call option" contract for 100 shares of GPI with a strike price of $120, expiring in four months. He pays a small premium for this contract.

  This is a stock-option contract because Alex has acquired the right (but not the obligation) to buy 100 shares of GPI stock at a specific price ($120) within a set period (four months). If GPI's stock price rises above $120 before the expiration date, Alex can exercise his option, purchase the shares at $120, and then sell them at the higher market price for a profit. If the stock price does not exceed $120, he can let the option expire, losing only the premium he paid for the contract, which is a much smaller amount than buying 100 shares outright.