What a strike price is worth

The value of an option has a floor you can calculate in one step. Share price minus strike price, times the number of options. That's intrinsic value.

Above the strike an option is in the money. Below it, underwater. At exactly the strike it is worth nothing to exercise today, which is where almost every option starts life, because companies set the strike at the share price on the grant date.

That raises an obvious question for a company with no share price. A private company has no market to read. So its board determines a fair value for the common stock, usually supported by an independent valuation, and options are struck at that figure. People refer to it by the section of the tax code that governs it and call it a 409A valuation.

The board's number is the strike. Whether it turns out to be low is only knowable later.

Reddit is the clearest case, because you can see both sides of the line.

Those options were struck while Reddit was private, at prices the board determined. Three months after that balance sheet date the company sold shares to the public at $34.00.

Intrinsic value at the offer price. $34.00 minus $17.83 is $16.17 per option. An employee holding 10,000 vested options at that average strike had about $161,700 of intrinsic value the day the stock began trading, before any tax and before any movement in the price afterwards.

Now the same idea at a public company. Oracle's exercisable options carried an average strike of $49.37 while options granted that year came in at $279.53. Two employees at the same company hold rights to the same share at strikes more than five times apart, purely because of when each grant was made.

The strike is a record of when you arrived.

The trap is treating a board-determined valuation as a market price.

It isn't one. It's an estimate made without a market, and it is usually well below what the shares later fetch publicly, partly because private shares cannot be sold freely and partly because the estimate is made earlier. Reddit's average strike was about half the eventual IPO price. That gap is normal, and it is also the whole reason early options can be worth a great deal.

What it does not mean is that the gap is owed to you. If the company never goes public and never sells, the strike is a price you can pay for something you cannot sell.

The second trap is comparing your strike with a colleague's and concluding someone was treated unfairly. A lower strike almost always means an earlier grant date at a lower valuation. It reflects timing, not generosity.

The third trap is the one that costs real money. Exercising an option can create a tax bill in the year you exercise, based on the gap between the strike and the current valuation, even when you cannot sell the shares to pay it. That is a circumstance-specific question and a good reason to speak to a tax professional before exercising anything illiquid.