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Employee Stock Options (ESOs)

Awards granted by a company to its employees. The value of the award ultimately depends on the performance of the employee and the performance of the company as a whole. ESOs are similar to traded call options in that the owner has the option to purchase shares of company stock at a specified date in the future at a specified price. However, ESOs are different from traded call options in significant ways such as: Maturity: ESOs usually have a much longer maturity, typically 10 years. Delayed Vesting: ESOs usually have a vesting period after grant. Exercise is not permitted during this period, which is typically three years. If employees leave the company during the vesting period, they forfeit these ESOs, whereas if employees leave the company after the vesting period of their ESOs, they forfeit out-of-the-money ESOs and must exercise in-the-money ESOs immediately; finally, employees cannot sell their ESOs and so are a call options only. Forfeiture: If employees leave the company during the vesting period of their ESOs, they forfeit these ESOs. If employees leave the company after the vesting period of their ESOs, they forfeit out-of-the-money ESOs and must exercise in-the-money ESOs immediately. Non-Transferability: Employees usually cannot sell their ESOs to other people. If employees need cash or want to diversify their portfolio, they must exercise the ESOs and sell the underlying shares. Because of this, ESOs are typically exercised earlier than similar traded options. Dilution: When ESOs are exercised, the granting company issues new shares of stock and receives cash in return. This changes the capital structure of the company.

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