Share Purchase Rights vs. Options (With Definition)

By Indeed Editorial Team

Published July 17, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Many companies often offer equity securities to their employees, enabling them to claim ownership of its asset. Share purchase rights and options contracts are typical securities that often give shareholders the ability to purchase an organization's shares. Learning the difference between these equity securities can help you determine how to exercise the rights to buy and sell them. In this article, we define share purchase rights vs. options, discuss their main differences, and provide examples.

Comparing share purchase rights vs. options

Comparing share purchase rights vs. options requires that you understand their definitions. Below are the meanings of these terms:

What are share purchase rights?

A share purchase right is a contract that gives a shareholder the option to purchase additional stock shares at a fixed price. This right may invite existing shareholders to buy more shares at a price the organization sets. Investors with a share purchase right can forgo it or sell it to another shareholder in the company if they don't want more investment. Existing shareholders are often entitled to purchase rights, as they can trade them in exchange markets. Companies may offer this right to improve their employee's performance and increase the stock price.

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What is an options contract?

An options contract is an agreement that gives a shareholder the right, but not the obligation, to purchase or sell a company's asset at a particular price before an expiration date. This contract gives the right to trade an underlying asset such as real estate, stock, and commodities at a price that's set in the future. Companies usually refer to this price as the strike price. Options contracts are generally available to new and existing investors.

There are two types of options contracts: the call or put. A call option gives a shareholder the right to buy shares of an underlying stock, while the put option gives the right to sell shares of an underlying stock.

Differences between share purchase rights and options

The following are the significant differences between share purchase rights and options:

Company ownership

Share purchase rights typically give holders the ability to purchase shares in addition to the ones they already have in a company. This means only shareholders of a company can buy these shares with purchase rights, giving them ownership. Meanwhile, options serve as a promise of ownership of an organization's share at a fixed price in the future. Options holders typically become full shareholders when they exercise their options into shares. Exercising a stock option means purchasing it at a price an issuer sets in the agreement. Any investor can buy options contracts.

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Cash outlay

A cash outlay refers to the money that an individual pays to start a new investment. Share purchase rights often require investors to exchange cash for the shares they buy. In many situations, an issuer may request a cash outlay below the market's value price to enable investors to make a profit for being loyal shareholders.

In contrast, options contract involves a premium or fee for the underlying shares. This contract holder receives a premium when they choose to sell their shares at the strike price. There's no cash outlay for employee stock options as the company gives its shares as incentives to enable them to participate in its ownership. An employee stock option is a contract that gives employees the right to purchase a particular number of shares at a price the company sets.

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Utility

Companies often use share purchase rights to raise capital, especially when they have a large debt. They can pay their debt easily with the funds they get from this right. Businesses may also use it to earn more revenue to cover expenses that can help them expand their operations. For example, an organization may use share purchase rights to acquire a new location or improve its production line. Doing this can help increase its shareholder's capital gains. A capital gain is a profit a holder makes by selling an investment higher than the purchase price.

Meanwhile, investors and traders often use options contracts to hedge market turndowns and control risks while minimizing share returns. With it, these individuals can potentially receive higher returns on shares. They may use it to purchase real estate or stock options. Options contracts also give traders the flexibility to construct time-sensitive and complex trades. Investors who buy options contracts rather than the underlying stock can use it to generate more profit from a smaller investment.

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Payment

Another main difference between share purchase rights and options is how holders purchase them. A share purchase right typically requires holders to pay a discount for the market value of the share they buy. In contrast, when an issuer grants an options contract, the holder pays a strike price at the period they choose to convert it into shares.

The strike price is generally a discount on the market value at the time an issuer granted the options contract. A market value is the price of an asset in a competitive market where the issuer and holder agree to transact independently. The strike price may be below market value when there's a tax implication.

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Elements of the agreement

A share purchase rights agreement typically contains the name of the company, par value of shares, name of the purchaser, number of shares the company wants to sell, and details of the transaction. This agreement may also contain the conditions for purchasing and terminating the contract. It also outlines the implications for investors not exercising their share purchase rights. Meanwhile, an options contract generally includes options type, strike price, underlying security, and expiration date.

Tax implications

Tax issues may arise when an individual invests in a share purchase right. Companies often offer shares under purchase rights at a discount to the current market price. This discount is typically subject to tax as a government considers it the receipt for a shareholder's payment of shares. The tax share purchase rights holders pay is usually the difference between the market value and the nominal value of the share. Many governments often count the difference between these values as an employment income.

Meanwhile, options holders and issuers don't pay tax. An options holder may only pay income tax when they exercise their options into shares. The income tax these individuals pay is typically the difference in price between the strike price and the current actual market value of the shares.

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Vesting

Vesting refers to the time holders earn options or share purchase rights. This means a shareholder can fully own a share or options after a vesting period elapses. Considering that companies issue shares immediately, it may require an existing shareholder who leaves before the vesting period ends to sell their unvested share purchase rights. This means the share purchase rights holder may sell their unvested share to another shareholder or back to the company at the nominal value.

In contrast, an options contract vesting period may vary, as companies use it to encourage holders to remain with them. An options holder may earn it in batches, usually between one to three years.

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Example of share purchase rights and options

Here are samples of share purchase rights and options:

Example of share purchase rights

The following is an illustration of share purchase rights in a company:

AquaQuater company wants to expand its operation to more cities, but it has a large debt and cannot borrow more money. The company gives its shareholders purchasing rights for shares to increase revenue. These shareholders exercise their rights and buy additional shares. When the company opens two new branches and becomes successful, it increases the share price, and the shareholders incur profits.

Example of options contracts

The following is an example of an investor exercising an options contract:

TipFlow bank expects Sunflower company's stock price to increase to $100 within a month. It discovers it can purchase an options contract from the company for $5 at a strike price of $80 per share. TipFlow bank may pay $500 to buy 100 shares for its options contract. Sunflower company's stock rises as the bank expects and stabilizes at $110. The bank immediately exercises the call options to buy underlying shares and acquire 100 shares of the company at $80 for $8,000.

TipFlow bank may choose to sell its new stock on the market at $11,000 because one share is presently worth $110. By doing this, it makes a profit of $2,500 ($11,000 - $8,000 -$500 = $2,500). The bank's profit is $2,500 because it removes the original $500 options contract and the $8,000 it pays to exercise the call option from the selling price.

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