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Lesson 5. Incentive Stock Options > Advantages of ISOs - Pg. 23

Incentive Stock Options 23 Unlike nonstatutory stock options, there are no discounting ISO exercise prices. This will be even more important when we look at employee stock options and the initial public offering in Lesson 10, "Taxes and Your Options." Caution Exercising ISOs and selling the stock involves important timing issues. Be sure you under- stand the holding period rule. The code does not prohibit an employer from setting the exercise price over the fair market value of the underlying stock at grant issue, although it would defeat some of the purpose of ISOs, which is to provide incentives for key managers to stay on the job. Granting them a worthless option would be counterproductive. There is a condition, however, when the option's exercise price must exceed the fair market value of the underlying stock. If the employee owns 10 percent or more of the voting stock, then he can only receive ISOs with an exercise price of at least 110 percent of the fair market value of the underlying stock on the date of grant issue. On top of that, the options may not be exercisable for more than five years after the date of the grant issue. These are the conditions under which owners of 10 percent or more of the stock can receive ISOs. Your legal counsel will undoubtedly explain this in more detail if you fall into this ownership category. Miscellaneous Points Incentive stock options are popular with highly paid managers; however, they come with some restrictions and conditions, as listed below: