What is the difference between share purchase rights and options?

There is a big difference between share purchase rights and options. With share purchase rights, the holder may or may not buy an agreed number of shares of stock at a pre-determined price, but only if he is already an existing stockholder.

Options, on the other hand, are the right to buy or sell stocks at a pre-set price. Unless otherwise stated, the buyer is under no obligation to do so, but he would have forfeited the fee that comes when he signs the option to purchase. The buyer does not necessarily have to be an existing stockholder to have access to options on a stock.

In effect, an outsider buys the right to purchase a stock via options; with share purchase rights, that right is already inherent for existing stockholders. In either case, there is an agreed-upon time frame to consummate the deal.

The differences between share purchase rights and options also hold true outside the stock market. They also apply to big-ticket items, such as real property, yachts, and airplanes.

For purchase rights, take the case of a startup tech company. The company announces the development of a consumer product that is expected to take the world by storm, such as a virtual reality headset no bigger than a pair of sunglasses. Initial reviews indicate that sales of the product will go through the roof once it is made available to the general public.

During its difficult first years of operations, when hiring good people is extremely difficult, the founder of the company offers stock purchase rights to his first group of employees and managers. Everyone who avails of the rights will be smiling all the way to the bank after the holiday sales in December.

With options, an individual can be one of 10 equal co-owners of a resort in the Bahamas, for example. All 10 have agreed that no outsiders may come in, and that if anyone wants to dispose of his shares, the purchase rights belong only to the nine other co-owners. Without such an agreement, an outsider would be allowed to come in on certain conditions, such as placing a deposit and agreeing to pay for the 10% stake being sold within an agreed-upon time frame.

It is possible that the person holding the option may win big or lose big. A billionaire may be willing to purchase the resort at double or triple its fair market value and be willing to pay cash even before the person holding the option has paid the agreed-upon price.

Since a contract has already been signed, and a deposit has been made, the agreement may not be rescinded. The holder of the option would have earned double or triple his investment prior to releasing the bulk of the purchase price.

By the same token, the resort may be totally destroyed by a natural disaster such as a tsunami or earthquake, which would not be covered by whatever insurance it has. Most insurance companies can refuse to pay by citing the disaster as an act of God. The would-be buyer has already signed a contract, so he will have to pay for the agreed-upon balance even if the value of the resort has dropped to zero.