What is a stock option?

Stock options are a financial tool that permits the option holder the ability to buy and/or sell shares of certain stocks for a specific duration of time and at a certain price. Stock prices can be greater or lower than what they were originally listed at and have an expiry date to them. Before the expiry date, the stock option holder has to determine whether to use the option by buying or selling the number of shares associated with the particular option, just selling the option as is without exercising it or letting the option expire altogether.

Companies are now offering their employees stock options as a form of financial incentive. These stock options are offered to the employee to buy company stocks at a discounted rate as put forth by the employer. There are many different stock options that employers can offer. Information on the different options can be found on the Canada Revenue Agency’s website. If you are looking for information on how stock options are taxed in Canada.

Workings of Stock Options

The price of a stock option is connected to the price fluctuation of the underlying stock it is associated with. In most cases, the option moves in the direction of the stock. If the stock rises the option will generally rise too. With one contract incorporating 100 shares, options are traded as a contract. An option’s premium is affected by a couple of parts. But first, what is a premium? The amount a buyer pays for an option is a premium. This premium is the maximum profit a seller of the option can obtain. Premiums paid or received are affected by:

• The intrinsic value – this is the difference between the market price and the strike price of the option. The strike price is the exercised price of an option.
• Time – the changes an underlying stock goes through during the time the option is held and the expiration of the option.

‘In the money’ is where the strike price of a call option is above the market rate. When the strike price is above the actual stock price, it is considered ‘out of the money’.

Terms to know:

• Call option permits the option holder to purchase the stock at a set rate within a specified time.

• Put option gives the buyer a right to sell their shares of the stock at a set rate within a specified time.

• Bid price – the amount the buyer is willing to pay for the option.

• Ask price – the price at which a seller is willing to sell.

Something to note is that since an option contract covers 100 shares, the bid and ask price would need to be multiplied by 100 to get the price. For information on stock options tax Canada.

Employee Stock Options

Employee stock options are different from listed stock options. They are not traded on an exchange and have specific attributes pertaining to them.

• The date on which an employee is offered the options is called a grant date.

• Timetable that covers when an employee gains full control over the options is the vesting schedule. This is different from company to company. This can occur over time or all at once.

A similarity to options traders is the decision to exercise an option. If not exercised by the expiry date the options become worthless.

How are stock options taxed in Canada?

Canadian Controlled Private Corporations (“CCPCs”)

A CCPC is a company that is for the most part incorporated in Canada and for which Canadian residents own and control the majority of the company’s voting shares. This must be a private company and as such would not be listed on public stock exchanges like the Toronto Stock Exchange.

When your employer grants you the stock options this does not have to be included in your taxable income at the time of grant. At this point, there should be no immediate tax consequences until you dispose of your options or exercise your options and sell your shares.  When you decide to purchase the shares through your employer, you will then need to include a taxable benefit to your income. The difference between the exercise price (your purchase price) and the market value of the shares at your time of purchase is equivalent to the taxable benefit. Employees of CCPCs are eligible for a special tax deferral and therefore the taxation of stock options in Canada in most cases can be deferred to the date of when shares are sold. This is to the benefit of the employee, as they will then have the funds to pay the tax resulting from the sale of their shares.

Public Companies and Employee Stock Options

In a publicly listed company, employees will have a taxable event on the date that the stock options are received or granted. The difference between the market value and exercised price of the stock options on your acquisition date is equal to your taxable benefit. This taxable benefit cannot be postponed unfortunately.

After buying the stock options, you can do one of two things

a. Immediately sell;

OR

b. Hold. If this is the way you decide to go, know that any future appreciation will be classified as a capital gain and will be subject to tax in Canada accordingly.

Whether you chose to sell or hold onto the company shares, the taxes will be deducted from your paycheck. This is to account for the taxable benefit on the purchase of your shares.Need more information on how stock options are taxed in Canada and how this may affect you?