For example, an employee may be given an option to purchase 50 shares of stock at $10 per share. Now let's say the price of the stock goes up to $20 per share. The employee is free to exercise the option by purchasing 50 shares of stock at $10 per share and then selling it for $20 per share, in this case making a profit of $500.

If the price of the stock never rises above $10 per share, the employee may never exercise the option because there would be no incentive for him to do so.

The advantage of stock option programs for employees is obvious. But there is also an advantage for the employer because it gives employees a financial interest in the company's success. Employees only realize a gain if the company succeeds and the stock price goes up. Therefore, stock options are only valuable to employees who plan to remain with the company for the long term. This benefits the employer by creating an added incentive for talented employees to remain with the company as it grows.

Business owner can generally offer two different kinds of employee stock option programs to their employees: incentive stock options and non-qualified stock options.

Incentive stock options allow employees to avoid paying taxes on the shares they own until those shares are sold. This provides a deferred-tax incentive for employees, which is another nice benefit. In some cases, the employee may also qualify for a long-term capital gains tax option.

Non-qualified stock options do not share the tax benefits of incentive stock options. However they do have the benefit of being more easily transferred to children than do their incentive stock option counterparts.

Employee stock options should never be offered as a substitute for an employee's normal compensation package, but rather as an added perk to inspire growth. During the internet boom of the 1990's, many start-up internet companies offered stock options in lieu of salaried compensation. When it was all over, the employees were left with nothing more than worthless stock options in defunct companies.

Many small business owners never consider employee stock options because their companies are privately owned as opposed to larger companies who sell shares to the general public. However, it is possible for smaller, privately-owned companies to offer employee stock options, especially if they anticipate going public at a future date.

Finally, if you do decide to offer a stock option program for your employees, your first step should be to consult a professional financial advisor who can guide you through the process and make sure your programs conforms to federal and state laws.