how are stock options created: company vs exchange

How this guide helps

This article answers the question how are stock options created for readers who want clear, practical guidance. You will learn the difference between company‑granted employee stock options and exchange‑traded options, the step‑by‑step processes that create each type, key legal and tax checkpoints, and hands‑on checklists for founders, HR teams and option holders. A short note highlights tokenized/DeFi options and where Bitget services can help with tradable, cleared derivatives and custody needs.

Note: the phrase "how are stock options created" appears throughout this guide to make the specific processes easy to search and reference.

As of March 2025, according to a market report, the US stock market opened with strong breadth and rising volatility patterns that can influence options demand and listing activity. This context underlines why understanding how are stock options created matters for both issuers and market participants.

Definitions and scope

Before diving into creation mechanics, define essential terms so readers new to the topic can follow along.

• Option: a contract giving the buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a set price before or at a set date.
• Call vs Put: calls give a right to buy; puts give a right to sell.
• Employee stock option (ESO): a company‑issued right to buy company shares at a pre‑set exercise (strike) price, typically conditioned on vesting.
• ISO vs NSO (NQSO): In the U.S., Incentive Stock Options (ISOs) have favorable tax rules but stricter eligibility; Non‑Statutory Options (NSOs/NQSOs) are more flexible but taxed differently.
• Exchange‑traded (listed) option: a standardized options contract listed on an options exchange and cleared centrally.
• Strike / exercise price: the price at which the option holder can buy (call) or sell (put) the underlying security.
• Vesting: the schedule that determines when an ESO holder earns the right to exercise granted options.
• Grant: the formal issuance of ESO rights to an employee or service provider.
• Option series: a set of exchange‑traded options with the same underlying, strike and expiration.
• Option premium: the price paid by an option buyer to acquire the option contract.

Scope: this guide focuses on (A) company‑granted employee stock options and (B) exchange‑traded listed options. Warrants and tokenized/DeFi options are covered briefly to show contrasts.

Types of stock options

Employee stock options (ESOs)

Employee stock options are call‑style rights granted by a company that allow employees to buy company common shares at a preset price after satisfying vesting and other conditions. Companies use ESOs to attract, retain, and align employees with shareholder value creation. For private companies, ESOs are also a primary means of providing equity compensation before an exit or public listing.

Exchange‑traded (listed) options

Listed options are standardized derivatives issued by exchanges with contract terms (contract size, strike intervals, expiration dates) specified centrally. They trade on regulated options markets and are cleared through a central counterparty, which reduces counterparty risk and enables broad liquidity for hedgers and speculators.

Other forms: warrants and tokenized options

• Warrants: long‑dated options issued by companies (often in financing) that are similar to ESOs but typically transferable and sometimes detachable from financing instruments.
• Tokenized / DeFi options: smart‑contract‑native option tokens minted on blockchains by protocols. They depend on on‑chain oracles and protocol rules rather than corporate boards or exchange listing committees. These are discussed briefly at the end.

How employee stock options are created (company process)

Below is the typical lifecycle for how are stock options created by a company, from plan adoption to administrative issuance.

Stock option plan and corporate authorization

Most companies begin by adopting a written stock option plan (often called an equity incentive plan) that defines:

• The size of the option pool (number of shares reserved),
• Eligibility rules (employees, directors, consultants),
• Types of awards (ISOs, NSOs, restricted stock units),
• Vesting rules, exercise mechanics, and expiration terms,
• Change‑of‑control treatment and repurchase rights.

Corporate approval is a legal prerequisite. Typically the board or the compensation committee adopts the plan and, in many jurisdictions and for many plan sizes, shareholder approval is required to comply with corporate law and stock exchange listing rules.

Grant approval and documentation

Individual grants are authorized under the plan by the board or its delegate (usually the compensation committee). A grant approval records key terms: grant date, number of options, exercise price, vesting schedule, expiration date, and any performance criteria.

Documentation delivered to the option recipient usually includes a grant notice and a grant agreement describing all material terms, transfer restrictions, and tax/withholding responsibilities.

Determining the exercise/strike price (public vs private)

When thinking about how are stock options created, the strike price is central:

• Public companies: the exercise price is typically set equal to the fair market value (FMV) of the company’s common stock on the grant date — usually the market closing price for publicly traded shares.
• Private companies: U.S. tax rules (Section 409A) require that stock options be issued with an exercise price at or above the company’s fair market value on the grant date to avoid adverse tax consequences. Private companies obtain an independent 409A valuation (from a qualified valuation firm) to determine FMV.

Setting the strike price below FMV can create immediate taxable income for option recipients and compliance issues for the company.

Valuation requirements (409A, Fair Market Value)

For private U.S. companies, a defensible 409A valuation is the standard method to determine FMV for option grants. A 409A valuation considers financial performance, comparable public companies, market transactions, and option pricing models. Companies typically update 409A valuations at least annually or more frequently after significant financing events.

Tax classification and grant documentation (ISOs vs NSOs)

Companies must designate whether an option is an ISO or a NSO at grant. ISOs are available only to employees and follow specific statutory rules (e.g., limits on grant value, holding period requirements) that affect how gains are taxed. NSOs are more flexible and can be offered to consultants or advisors but create ordinary taxable income to the recipient upon exercise (difference between FMV and exercise price) and withholding obligations for the employer.

Administrative issuance and the equity ledger

Once a grant is approved and documented, it is recorded on the company’s cap table and equity management system. For private companies, electronic equity administration platforms or legal counsel typically create formal grant paperwork and maintain an option ledger. Employees receive grant notices and subsequent exercise forms when they choose to exercise options.

Recording grants accurately is critical for dilution tracking, reporting, and eventual share issuance on exercise.

How exchange‑traded stock options are created (market process)

Understanding how are stock options created on exchanges requires a different view: these options are not issued by the underlying company but created and listed by options exchanges and made tradable by market participants.

Standardization and contract specifications

Options exchanges define standardized contract terms: the underlying security, contract size (often 100 shares per contract in U.S. equity options), available strike intervals, expiration cycles (monthly, weekly, quarterly), and exercise style (American vs European). Standardization ensures fungibility and enables robust secondary markets.

When asking how are stock options created for a listed stock, the first step is the exchange’s decision to list option series for that underlying.

Listing of option series

Exchanges periodically add option series for an underlying stock based on demand and listing rules. Initial series may include a set range of strike prices around the current share price and common expirations. As market demand and volatility change, exchanges and their listing committees may add additional strike prices or expirations (e.g., weekly options). The listing process is governed by exchange policies that assess liquidity, market capitalization and compliance factors.

Role of market makers and liquidity providers

Market makers are key to how are stock options created in practice. They post two‑sided quotes (bid and ask) and provide continuous liquidity that enables buyers and sellers to transact. By quoting options actively, market makers effectively seed tradability and help compress bid‑ask spreads, which encourages more trading and leads to additional option series being added.

Clearing and the central counterparty (OCC)

In the U.S., the Options Clearing Corporation (OCC) or a similar central counterparty clears exchange‑traded options. Clearing does several things:

• Guarantees contract performance by stepping in as buyer to every seller and seller to every buyer,
• Nets offsetting trades across participants to reduce overall settlement obligations,
• Manages exercise and assignment processes when options are exercised or assigned.

The clearinghouse infrastructure is one reason listed options can scale to huge volumes while controlling counterparty risk.

Option pricing and market formation

Option premiums on exchanges are set by supply and demand and guided by pricing models (e.g., Black‑Scholes) and the market’s implied volatility. Traders and algorithms price options based on expected underlying movement, time to expiration, dividends, interest rates and implied volatility. The interplay of these variables determines how are stock options created, quoted and repriced in live markets.

Lifecycle of an option (from creation to expiration)

For ESOs: grant → vesting → exercise → sale / post‑exercise holding

• Grant: company issues options under a plan and documents the award.
• Vesting: the employee becomes eligible to exercise according to schedule (e.g., 4 years with a 1‑year cliff).
• Exercise: when vested, the holder pays the exercise price and acquires shares. Exercise methods include cash exercise, cashless exercise (broker facilitates sale to cover exercise cost and taxes), or net settlement if permitted.
• Post‑exercise: after exercise, shares are subject to company transfer restrictions (especially in private companies) and may be held, sold, or transferred according to plan rules.

Companies typically define post‑termination exercise windows (e.g., 30–90 days after termination) unless extended by special provisions like change‑of‑control acceleration.

For exchange‑traded options: listing → trading → assignment/exercise/expiration

• Listing: exchange lists option series and market makers provide quotes.
• Trading: buyers and sellers trade contracts; prices move with underlying and volatility.
• Exercise/Assignment: American‑style options can be exercised any time before expiration; European‑style only at expiration. When an option is exercised, the clearinghouse assigns an offsetting writer, and settlement occurs — typically involving physical delivery of shares (or cash settlement for index options).
• Expiration: if options expire out‑of‑the‑money, they lapse worthless; in‑the‑money options may be exercised or automatically exercised depending on exchange rules.

Accounting, financial reporting and tax considerations

Accounting (ASC 718 / IFRS 2)

Companies expense stock‑based compensation under ASC 718 (U.S. GAAP) or IFRS 2. The fair value of options at grant is estimated (commonly via Black‑Scholes or binomial models) and recognized as compensation expense over the vesting period. Key disclosure items include total expense recognized, assumptions used in valuation (volatility, term, risk‑free rate), and the effect on diluted EPS.

Tax consequences for recipients and issuers

• ISOs: may qualify for favorable capital gains tax treatment if holding requirements are met, but exercise can trigger Alternative Minimum Tax (AMT) exposure in the U.S.
• NSOs: exercise typically creates ordinary income equal to the difference between FMV and exercise price; the employer must withhold appropriate payroll taxes.

Employers must report compensation amounts and meet withholding and reporting obligations. For private companies, providing liquidity for employees to pay taxes on exercise is an important operational consideration.

Valuation methods used by companies

Black‑Scholes, binomial models and Monte Carlo simulations are commonly used to estimate grant‑date fair value. For private companies, these models rely on 409A FMV inputs and assumptions about volatility, expected term, and liquidity discounts.

Differences between private and public company option creation

Private and public companies follow different operational and compliance practices when creating options:

• Strike price setting: public companies can use observable market prices; private companies use a 409A valuation.
• Liquidity: public company option holders can often exercise and sell immediately; private company holders usually face transfer restrictions and limited secondary markets.
• Valuation & accounting: both expense awards under ASC 718/IFRS 2, but private companies face additional challenges in valuing underlying common stock and forecasting expected terms.
• Administration: private firms often rely on equity management platforms and legal counsel to administer grants, whereas public companies manage larger, more complex programs with broader disclosure obligations.

These differences shape how are stock options created and managed across company life cycles.

Legal and regulatory framework

Securities laws and disclosure

Option grants to insiders trigger securities reporting obligations in many jurisdictions. For example, in the U.S., grants and subsequent sales by officers and directors often require Form 4 reporting under SEC rules. Employee grants may qualify for private‑placement exemptions, but compliance with securities and employment law remains essential.

Exchange and clearing regulations

For listed options, exchanges and clearinghouses impose listing standards, margin requirements for writers, and surveillance rules to ensure orderly markets. Compliance with these rules underpins the safety and integrity of listed options markets.

Practical considerations and common employer/employee practices

Typical vesting schedules, cliffs and performance vesting

Common patterns include four‑year vesting with a one‑year cliff (25% after year one, then monthly or quarterly thereafter). Companies may include acceleration clauses (single or double trigger) for change‑of‑control events, or performance‑based vesting tied to revenue, product milestones or market metrics.

Exercise methods and liquidity planning

Employees should plan for exercise costs and tax consequences. Exercise methods include:

• Cash exercise: employee pays exercise price in cash.
• Cashless exercise: broker arranges sale of some shares to fund exercise and taxes.
• Sell‑to‑cover: employee sells just enough shares to cover exercise costs.

Private‑company employees often face the challenge of finding liquidity to exercise; employers sometimes offer exercise assistance programs or allow limited secondary sales under specific policies.

Bitget note: for employees who receive tradable listed options or want to hedge option exposure in markets where Bitget lists options or derivatives, Bitget provides trading and custody tools. For private company holders, Bitget Wallet can be used to manage tokenized representations of equity when compliant and supported by the company.

Impact on cap table and dilution

Option pools dilute existing shareholders when options are exercised and shares are issued. Founders and investors must model expected dilution, run‑rate of new grants, and the effect of option exercises on ownership percentages. Proper cap table management is essential at each financing or exit event.

Risks, limitations and common misconceptions

• Options can expire worthless: they have limited life and require favorable share movement.
• Not guaranteed compensation: options are contingent rights, not salary substitutes.
• Tax traps: ill‑timed exercise or failure to meet ISO holding requirements can create unexpected tax liabilities.
• Options ≠ RSUs: restricted stock units (RSUs) typically deliver shares without exercise cost and behave differently for tax and liquidity.

Understand both upside potential and practical constraints before relying on options as primary compensation.

Options in decentralized finance / tokenized options (brief note)

Tokenized or DeFi options are created through smart contracts that mint option tokens when protocol conditions are met. These option tokens can be traded on decentralized exchanges or used in liquidity pools. Their creation differs from corporate or exchange systems because they depend on code, on‑chain oracles for price feeds, and protocol governance rather than corporate boards or exchange listing committees. Use audited contracts and secure wallets; for custody and trading of tokenized option instruments, Bitget Wallet is recommended where supported.

Frequently asked questions

Q: Who approves option grants? A: Company option plans are adopted by the board and usually require shareholder approval; individual grants are typically approved by the board or a compensation committee or their delegate.

Q: How is exercise price set for a private company? A: For U.S. private companies, a 409A valuation determines fair market value, and the exercise price is set at or above that FMV to avoid adverse tax consequences.

Q: What happens if I leave before vesting? A: Unvested options are typically forfeited on termination unless the plan or grant agreement states otherwise. Some companies offer accelerated vesting for certain events.

Q: How are exchange options added by exchanges? A: Exchanges list option series based on listing rules, underlying liquidity and market demand. Market makers and trading volume drive the addition of new strike prices and expirations.

Q: Can a private company issue ISOs to contractors? A: No. ISOs are restricted to employees; consultants and advisors must generally receive NSOs if they receive option awards.

References and further reading

Sources used to inform this guide include market and practitioner resources on employee and exchange‑traded options, option accounting, and private company valuation. Recommended materials include corporate equity plan guides, tax references on Section 409A, practitioner resources on grant administration, and exchange/clearinghouse documentation on listed option standards.

(Representative sources: Carta, Digits startup plan guides, myStockOptions and major investment‑bank primers on ESOs, Investopedia and iShares options primers, NerdWallet employer/employee explainers.)

Example templates and practical checklist (appendix)

Use this checklist when asking how are stock options created at your company or when evaluating an offered grant:

For founders and HR teams:

• Adopt a written equity incentive plan and obtain required approvals.
• Set the option pool size and document dilution expectations.
• Arrange for a defensible 409A valuation (for private U.S. companies).
• Create standard grant agreements with clear vesting, exercise, and termination provisions.
• Implement an equity administration platform and update the cap table.
• Communicate grant terms and tax implications clearly to recipients.

For employees receiving a grant:

• Confirm grant date, number of options, exercise price, vesting schedule, expiration and change‑of‑control provisions.
• Ask whether the options are ISOs or NSOs and what tax implications apply.
• Model exercise costs, tax withholding and possible liquidity events.
• Keep paperwork and exercise notices in a secure place and plan for tax dates.

Practical examples of creation scenarios

Example 1 — Early‑stage private company:

A seed stage company sets up a 10% option pool through board approval and shareholder consent at incorporation. The board authorizes individual grants to early hires. The company obtains a 409A valuation; each grant’s exercise price equals the 409A FMV. Grants vest over four years with a one‑year cliff. When an employee exercises, the company issues restricted common shares post‑exercise and records the issuance on the cap table.

Example 2 — Public company listed options:

An exchange decides to list weekly options for a large‑cap stock. Market makers quote a slate of strikes around the current price and provide continuous two‑sided markets. Traders buy and sell these listed options; the clearinghouse nets trades and stands ready to manage exercise and assignment. Option premiums reflect implied volatility and time value.

Actionable next steps

If you are a founder or HR leader: ensure your equity plan and grant procedures are legally compliant, supported by a recent valuation and an equity administration tool.

If you are an employee: carefully read your grant agreement, model taxes and exercise cost, and consult a qualified tax advisor if needed.

If you trade or hedge listed options: understand contract specifications, clearinghouse rules and the role of implied volatility. For trading, custody, and derivatives services, consider Bitget’s platform and Bitget Wallet as integrated solutions to manage positions and settle compliant derivatives.

Further explore Bitget tools to track option‑related positions and custody solutions for digital tokenized instruments.

Final thoughts and further exploration

Questions of how are stock options created touch both corporate governance and market infrastructure. Whether you are negotiating offers, structuring an employee plan, or trading listed options, a clear grasp of the creation mechanics, tax and accounting implications, and liquidity realities will reduce surprises.

To learn more about tradable options and custody for tokenized derivatives, explore Bitget’s product suite and Bitget Wallet to see practical tools for traders and employees managing option‑related exposures.

Thank you for reading—use the checklist above as a practical starting point and consult qualified legal or tax counsel for case‑specific advice.