A compensatory equity award granted by a company to an employee or other individual performing services for the company. There are two types of stock options: nonqualified stock options and incentive stock options or ISOs. ISOs have certain tax advantages from the employee's perspective if the requirements of Section 422 of the Internal Revenue Code (26 U.S.C. § 422) are met.

In general, a stock option provides the employee or other service provider with the right (but not the obligation) to purchase employer stock at a specified price at the end of a specified vesting period. The exercise price is typically the fair market value of the stock at the time the option is granted. The vesting is commonly time-based (or, less often, performance-based).

Once vested, a stock option is exercisable for a specified period of time (the exercise period). If the stock option is not exercised during the exercise period, it is forfeited. If a stock option is granted with an exercise price that is less than the fair market value of the underlying shares on the grant date, this can cause adverse tax consequences for the option holder under Section 409A.

For further information on stock options, see Practice Note, Stock Options: Overview. For a model stock option agreement to be used for grants to employees, see Standard Documents, Non-Qualified Stock Option Agreement (Employees) and Incentive Stock Option Agreement. For information on the requirements of ISOs, see Incentive Stock Options Checklist.