The definition
A stock option is the right, but not the obligation, to buy a share of the company at a fixed price, called the strike price or exercise price, at some point in the future. If the company's value rises so that each share is worth more than the strike, you can exercise the option, buy at the lower strike, and own a share worth more than you paid. If the share price never rises above the strike, the option is worthless and you simply do not exercise it. This is the fundamental difference from an RSU, which is a share you receive outright and which retains value as long as the stock is above zero.
Options are most common at startups and earlier-stage private companies, where the strike price is set low because the company is currently worth little, giving large upside if it grows. Two main flavours exist in the US system: incentive stock options (ISOs), which can have favourable tax treatment if you meet holding requirements, and non-qualified stock options (NSOs), which are taxed as ordinary income on the gain at exercise. The distinction matters a great deal for your eventual tax bill.
How options work and where the risk lives
When you join, you are granted a number of options that vest over time, typically four years with a one-year cliff, just like RSUs. Vesting only gives you the right to exercise; to actually own the shares you must pay the strike price for each one, which can require real cash. Many options also expire shortly after you leave the company, often within ninety days, forcing a decision about whether to spend money exercising into an illiquid private stock you cannot easily sell.
The risk in options is concentrated and real. At a startup, the shares may never become liquid, the company may not exceed the valuation implied by your strike, and you may face a tax bill on a paper gain you cannot turn into cash. The same headline number that looks generous in an option grant is worth far less, in expectation, than the equivalent value in public-company RSUs, because it is contingent on a successful exit that may not happen. This is why option grants should be discounted heavily when comparing offers.
Why options matter when evaluating an offer
If an offer is paid largely in stock options, the most important questions are about the underlying reality rather than the headline grant. What is the strike price, and what is the current preferred-share valuation? How many shares are outstanding, so you can estimate your actual ownership percentage? What is the post-termination exercise window, and could you afford to exercise if you left? Without these answers, the grant is just a number with no defensible value.
For your total compensation calculation, treat private-company options conservatively. Unlike public RSUs, you cannot annualise them at face value with any confidence, because the value depends entirely on a future event. Many experienced candidates effectively weight startup option value at a steep discount and lean on base salary, which is guaranteed cash, when comparing a startup offer against a public-company package. The upside can be life-changing, but it is a bet, and it should be sized like one.
Frequently asked questions
- What is the difference between stock options and RSUs?
- A stock option is the right to buy a share at a fixed strike price, so it only has value if the market price rises above the strike, and you must pay to exercise. An RSU is a share given to you for free when it vests, which has value as long as the stock is above zero. Options carry more upside and more risk; RSUs are simpler and lower-risk.
- What is a strike price?
- The strike price, or exercise price, is the fixed amount you pay to buy each share when you exercise an option. It is usually set to the company's fair value at grant. Your gain is the difference between the market price and the strike, so a low strike on a company that grows a lot is where the upside comes from.
- Can stock options become worthless?
- Yes. If the share price never rises above your strike price, the options have no value and there is no reason to exercise them. At startups, shares can also stay illiquid for years or the company can fail, so option grants should be valued conservatively and discounted heavily compared with public-company RSUs when you compare offers.