A Non-Qualified Stock Option (NSO) is a stock option that does not qualify for ISO tax treatment under IRC Section 422. It is taxed as ordinary income on the bargain element (FMV at exercise minus strike price) at exercise, with subsequent appreciation treated as capital gain on sale, and granted broadly to employees above the ISO cap, contractors, board members, advisors, and consultants who aren't W-2 employees. It is the workhorse option type for non-employee grants and for employee grants exceeding the $100,000 ISO annual cap.
The NSO mechanic and the tax rules: