But how do you determine if (not when) you should exercise? I am trying to make this decision for a company I recently left. I don't know when they'll IPO. I know they wanted to, but the market is getting slammed, and they just announced layoffs. I don't have much confidence in the company, so I am having a hard time understanding the risk. I don't really even understand what happens if they don't ever IPO and I have purchased options.
You are in a space I don't understand. (I don't even understand how/where you purchase options if it is not publicly traded and you are not an investor!)
Sorry, that's a PhD-level question, I'm still at options 101. :(
The company itself issues you the options, usually as a form of compensation because you're an employee, etc.
That option is a certificate that gives you the ability to purchase a share of the company at a specific price (the strike price). Usually when people say "buy their options" or "exercise their options", they are referring to buying the _stock_ that their options gave them the ability to purchase.
So if I join a startup, they grant me 100 options with a strike price of $0.50, and I decide to exercise them, I would write the company a check for $50 and get 100 shares of the company in exchange.
It comes down to whether or not you think the company will have a successful liquidity event.
If you think the company is going to shutdown, or sell at a lower valuation than your option's strike price, don't exercise them. Your shares will be worthless.
If you think they'll succeed and IPO or get acquired at a higher price, buy them (factoring in any potential tax implications, like AMT). It is a risk.
