Stock Options: What They Are and How They Work

By Lyle Daly – Updated Apr 3, 2025 at 1:37 PM

Key Points

Stock options grant the right to buy or sell a stock at a set price and are profitable if predicted accurately.
Employee stock options (ESOs) allow employees to buy company stock, tying compensation to company performance.
Options are risky; they lose value over time and need precise market timing predictions.

Stock options are both a type of investment and an equity compensation some companies offer their employees. If the stock price moves in the investor’s favor, options can be highly profitable, but there are also risks involved.

Loading paragraph...

Man leading business meeting — Image source: Getty Images.

Loading paragraph...

However, options are far from an easy way to make money. Stock options continually lose value as they get closer to the expiration date, and if your option doesn’t move past the break-even point, it will expire and be worthless. Options are also more complicated than a buy-and-hold strategy. If you simply invest in quality stocks, you can take a long-term approach. If you trade options, you need to predict not just which way a stock price is going to move, but how soon it will happen, so you can pick the right expiration date.

As far as ESOs go, ideally, they work out well for the employer and the employee. There’s no additional cost for the employer, and the employee gets the opportunity to share in the company’s success. Of course, it’s important for a prospective employee to consider the company’s growth prospects, since stock options won’t be worth anything if the company loses value.

Loading paragraph...

Related investing topics

Loading paragraph...

Traditional 401(k) vs. Roth 401(k): What's Best for You?

Employers often offer both plans for you to choose from. Here's how to do it.

Loading paragraph...

About the Author

Lyle Daly is a contributing Motley Fool stock market analyst covering information technology and cryptocurrency. Lyle has been a contributor at the financial services company since 2018. His work has been featured on USA Today, Yahoo Finance, MSN, Fox Business, and Nasdaq. Before joining The Motley Fool, he wrote for financial brands including Intuit.

TMFLyleDaly

@LyleDaly

Lyle Daly has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.