Bargain element

An option lets its holder buy a share for the strike. If the share is worth more than that on the exercise day, the holder has paid less than the share's value, and the gap is the bargain. Per share it is the fair market value minus the strike; for an exercise it is that gap times the shares exercised.

The spread is not a gain from a sale. It exists on paper the moment the exercise happens, whether or not the shares can be sold, and at a private company they may not be sellable. It is measured once, at exercise, and does not change afterwards; movement in the share price after that date is a capital gain or loss.

The two names are one figure in two roles. Before exercise it is the spread, what vested options are worth today; at exercise it becomes the bargain element, the amount the tax code counts as compensation for the shares.

An employee exercises 1,000 options with a $2.00 strike on a day the company's 409A is $5.00. The bargain element is $3.00 a share, or $3,000.

On an NSO that $3,000 is ordinary income in the year of the exercise. On an ISO it is added back in that year's AMT calculation, and it becomes ordinary income only if the shares are sold before the ISO holding periods end.

FMV at exercise, per share

$5.00

Strike, per share

− $2.00

Spread per share

$3.00

Shares exercised

× 1,000

Bargain element

$3,000

The bargain element is what gets taxed at exercise, and its size depends on the FMV that day. The same 1,000 options exercised at a $3.00 valuation carry a $1,000 spread; at $5.00, $3,000. The cash cost, the strike, is the same either way.

On an NSO the spread is compensation income in the exercise year, and the shares' cost basis becomes the FMV at exercise. On an ISO it is an AMT adjustment in the exercise year, and on a disqualifying sale it turns into ordinary income, capped at the gain on the sale when it is a sale on which a loss, if sustained, would be recognized.

When the FMV is below the strike, there is no spread and the options are underwater.

Taiga Finance shows a grant's spread in its drawer as “Spread today”, per share, with the dollar figure on the exercisable shares underneath, at the company's latest 409A or market price. When the FMV is below the strike, the per-share figure is negative and the dollar figure on exercisable shares reads $0. A vested option's value across the app is that spread; unexercised options stay out of net worth.

The year's figures note which spread still carries AMT preference. A recorded ISO sale inside the holding periods is split into ordinary income and gain in the exercise history.