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What is a Non-Qualified Stock Option?

By Luke Arthur
Updated Feb 23, 2024
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A non-qualified stock option allows a buyer to purchase stock at a certain price, but he will have to pay income taxes on the gains generated by selling it. This differs from an incentive stock option, which "qualifies" for a tax benefit, but must be held for a specific amount of time before it can be sold. Non-qualified stock options are very common in the financial world, and can provide individuals with a way to bring in substantial returns in the stock market under the right conditions. This type stock option is a benefit often offered to employees to enable them to purchase a certain amount of company stock at a predetermined price.

In most cases, a non-qualified stock option will be offered to employees who are not at the executive level. Most executives receive incentive stock options instead. When an employee receives a non-qualified stock option, he or she can use it to purchase a certain amount of stock in the company at a specific price. The stock option has to be exercised by a certain date in order to be utilized.

This option can enable employees to reap significant returns in the stock market. For example, if an employee receives a stock option in the company and the price of the stock goes up significantly, he or she can buy the stock for much less than what it is selling for in the market. The employee can then take the stock and immediately sell it in the market to make a profit. The employee also has the option of holding onto the stock and selling it in the future.

With a non-qualified stock option, the individual has to pay taxes on the difference in the price that he or she paid for the stock and the price at which it is sold. With incentive stock options, this is not the case; however, incentive stock option owners have to keep the stock for an extended period of time in order to realize this benefit. With non-qualified stock options, the owners can immediately sell the stock and realize a profit.

In most cases, employees have to stay with a company for a certain amount of time to gain full ownership of the stock options. This process is known as vesting, and it is very common in the financial industry. This helps retain talented employees and keeps them from having full access to the stock immediately.

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