Know When To Hold ‘Em
Telling when to exercise your company stock options
should be based on more than your gut about a potential
market price peak.
If the stock options you’ve received from your employer are burning a hole in your pocket, it may be time
to get a second – or third – opinion before you cash in. Employees often believe they have the inside
scoop on when the stock’s market price will top out, and that false sense of confidence can lead you to
exercise too soon and regret it later.
Employees with true inside information – specific knowledge about the company that will impact the
market price when made public – cannot sell company stock based on that inside information. You don’t
want to end up in Sing-Sing, so be careful if you’re privy to important information.
That said, a financial advisor can provide needed guidance about your stock
options. The first step is to set goals: What role do the stock options have in your
overall financial plan? Paying off your mortgage, funding a child’s education and
retirement may be uses for stock options, depending on the rest of your portfolio
and the amount of time left to exercise the options.
Become educated about your stock options: the terms of their exercise, tax
issues and gain-loss consequences. The two types of options – nonqualified
and incentive – have very different tax treatment that could consume a large
portion of any profit you gain when you exercise the option and then sell the
stock. You should consult a tax advisor about implications of exercising options,
based on your specific tax bracket and information.
The value of your stock options lies in more than just the difference between
exercise price and market price. The time remaining before the options expire
(also referred to as time value or leverage), your concentration in your employer’s
stock and tax impact all factor into determining the true value of your stock options.
Stocks, historically, increase in value over time – although there is never a
guarantee on that. By waiting to exercise, you may enjoy all the upside potential
without any cash investment, and that difference between the exercise price and
the market price grows untaxed. Conversely, if the stock price declines while you
continue to hold the stock options, their potential value may be reduced to zero.
The exception to the “hold ‘em” rule lies in that stock concentration issue. Your
salary already depends on your employer. Having too much of your future also
tied to your employer can result in a double whammy if the company runs into
trouble – loss of income and loss of potential gains from your stock options. As
a rule of thumb, if stock options account for more than 25 percent of your net
worth, you may want to consider exercising, selling and diversifying your portfolio.
This risk management tactic can provide more value than the additional gains you
would see if you held the options for the full period.
The other caveat on holding stock options lies in that important tax issue. Waiting until the last minute to
exercise incentive options reduces your control over when gains are taxed.
Don’t confuse widespread with simple. Although a growing number of companies now use stock options
as part of their compensation or incentive packages, they remain a complex investment device. You
should consult with a financial advisor and a tax professional on how to plan the exercise of your stock
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