Author Topic: When to exercise stock options?  (Read 6355 times)

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
When to exercise stock options?
« on: May 17, 2013, 06:42:45 PM »
I've been reading that at general rule of thumb is that you should wait as long as possible to exercise stock options, assuming you work for a stable company. I work for a very large company that is completely stable. The stocks have risen along with the market and then some--over 30% since they were granted to me a few months ago. Is the MMM opinion the same as the rule of thumb? Should I hold onto these for 10 years? Or is it better to exercise sooner and diversify from the company? I'd love to hear thoughts on this from the peanut gallery!

Joet

  • Guest
Re: When to exercise stock options?
« Reply #1 on: May 17, 2013, 07:02:54 PM »
speaking for no one other than myself, there's AFAIK only 2 schools of thought:

1] sell immediately on vesting, pay your marginal income tax rate
2] sell after 12 months to secure long term cap gains, pay the 15% or whatever it is now

once sold, invest per your AA


anything else risks enron-dom. Sure apple/goog/XOM/etc or the other fortune 50/100 members could never have a problem. until they do.

personally I do a combination of 1 & 2, and of course, my stable fortune 50 company could never go down either, heh *knocks on wood*

bdub

  • 5 O'Clock Shadow
  • *
  • Posts: 77
  • Location: Minneapolis, MN
Re: When to exercise stock options?
« Reply #2 on: May 17, 2013, 07:52:15 PM »
speaking for no one other than myself, there's AFAIK only 2 schools of thought:

1] sell immediately on vesting, pay your marginal income tax rate
2] sell after 12 months to secure long term cap gains, pay the 15% or whatever it is now


#2 isn't accurate:  we are talking about stock options.  You would need to BUY them, then hold them for 12 months and sell for LT capital gains.  If you go this route, be prepared to pay tax on any short-term gain realized when they are purchased vs. market rate.

IMHO:  Sell them when they vest.  Diversify away from your employer.

Joet

  • Guest
Re: When to exercise stock options?
« Reply #3 on: May 17, 2013, 08:11:43 PM »
I suppose, I was talking about RSU's [the only ones I get], and it's accurate for that. Your taxable event occurs when it vests, whether you buy, same-day-sale, sell-to-buy, or any combination.

http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp

*I think, heh. I'm probably wrong lol
« Last Edit: May 17, 2013, 08:13:26 PM by Joet »

Roland of Gilead

  • Handlebar Stache
  • *****
  • Posts: 1686
Re: When to exercise stock options?
« Reply #4 on: May 17, 2013, 08:45:13 PM »
If they are really 10 year options I might be tempted to sell 1 year dated far out of the money naked calls on the shares that are vested. 

Example if your company was, say, Cisco.

You were granted 4000 options at a strike of $22.

Cisco is trading at $24.24 when your shares vest.  Instead of selling the vested options for $2.24, you instead write 40 Jan 2014 $26 call contracts and immediately collect $3520.  You don't owe tax on this until 2014.

If Cisco is above $26 in Jan 2014, you then exercise your company options and use the proceeds to buy back the $26 calls you wrote and collect an additional $16,000 net profit.

So your total profit in that case was $19,520 vs $8,960 if you had exercised the options immediately when vested.

To do this of course, you need to be liquid enough to cover the naked calls you write during the time it will take you to exercise your company options and get the proceeds.  The income from the initial sale of the calls can help with this liquidity since you don't even pay tax on it for a year.

In the case where the stock stays flat for 10 years, you could end up with tons of money in call writing premium.   There is a lot of value in 10 year stock options.  The longest you can buy an option on the open market is about 2 years.

Some companies may have a policy that doesn't let you sell short...but I am not really sure how they would find out if you were doing this in a private trading account.

bdub

  • 5 O'Clock Shadow
  • *
  • Posts: 77
  • Location: Minneapolis, MN
Re: When to exercise stock options?
« Reply #5 on: May 18, 2013, 07:04:42 AM »
I suppose, I was talking about RSU's [the only ones I get], and it's accurate for that. Your taxable event occurs when it vests, whether you buy, same-day-sale, sell-to-buy, or any combination.

http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp

*I think, heh. I'm probably wrong lol

You are correct about RSU's (with the exception of the sell-to-cover shares which are taxed at ST rates if you go that route).

icefr

  • Bristles
  • ***
  • Posts: 325
Re: When to exercise stock options?
« Reply #6 on: May 18, 2013, 09:34:27 AM »
I suppose, I was talking about RSU's [the only ones I get], and it's accurate for that. Your taxable event occurs when it vests, whether you buy, same-day-sale, sell-to-buy, or any combination.

http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp

*I think, heh. I'm probably wrong lol

You are correct about RSU's (with the exception of the sell-to-cover shares which are taxed at ST rates if you go that route).

Sure, but there's no gain since you're selling same day, so your tax liability is zero. I actually claim short-term capital losses on mine due to the commissions.

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
Re: When to exercise stock options?
« Reply #7 on: May 18, 2013, 11:55:36 AM »
If they are really 10 year options I might be tempted to sell 1 year dated far out of the money naked calls on the shares that are vested. 

Example if your company was, say, Cisco.

You were granted 4000 options at a strike of $22.

Cisco is trading at $24.24 when your shares vest.  Instead of selling the vested options for $2.24, you instead write 40 Jan 2014 $26 call contracts and immediately collect $3520.  You don't owe tax on this until 2014.

If Cisco is above $26 in Jan 2014, you then exercise your company options and use the proceeds to buy back the $26 calls you wrote and collect an additional $16,000 net profit.

So your total profit in that case was $19,520 vs $8,960 if you had exercised the options immediately when vested.

To do this of course, you need to be liquid enough to cover the naked calls you write during the time it will take you to exercise your company options and get the proceeds.  The income from the initial sale of the calls can help with this liquidity since you don't even pay tax on it for a year.

In the case where the stock stays flat for 10 years, you could end up with tons of money in call writing premium.   There is a lot of value in 10 year stock options.  The longest you can buy an option on the open market is about 2 years.

Some companies may have a policy that doesn't let you sell short...but I am not really sure how they would find out if you were doing this in a private trading account.

I'm not sure I understand this. Could you explain the naked calls? I'm not understanding the tax implications. Thank you for the advice!

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
Re: When to exercise stock options?
« Reply #8 on: May 18, 2013, 11:58:45 AM »
IMHO:  Sell them when they vest.  Diversify away from your employer.

Thank you. So you think it's smarter to pay the taxes upon sale and then just reinvest into index funds or something? So let's say my options are worth $50,000 upon vesting. I pay income tax on the grant price and then 15% on capital gains. So then let's say it's worth $25,000 after taxes. It's still better to sell immediately and reinvest?

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
Re: When to exercise stock options?
« Reply #9 on: May 18, 2013, 11:59:20 AM »
I suppose, I was talking about RSU's [the only ones I get], and it's accurate for that. Your taxable event occurs when it vests, whether you buy, same-day-sale, sell-to-buy, or any combination.

http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp

*I think, heh. I'm probably wrong lol

Thanks, Joet. I actually get RSUs too so this is helpful!

Roland of Gilead

  • Handlebar Stache
  • *****
  • Posts: 1686
Re: When to exercise stock options?
« Reply #10 on: May 18, 2013, 01:03:55 PM »

I'm not sure I understand this. Could you explain the naked calls? I'm not understanding the tax implications. Thank you for the advice!

A covered call is when you sell a stock option contract (a contract is for 100 shares of stock) against actual stock you own.

So if you owned 100 shares of Cisco you could sell 1 covered call option contract

Selling a call when you don't own the actual stock is selling a naked call.  You are responsible for buying the shares and delivering them to the option buyer when he decides to exercise the option.

In your case, there is no risk (assuming you keep your job and your options are vested) even though you don't own the stock because you have a 10 year stock option that is at a lower strike that the naked call you propose to sell.

When you sell a covered call or naked call, you don't pay tax on the proceeds from the sale until the call has been exercised or bought back by you.  In this case if you sold Jan 2014 calls, you would collect the money now on the sale and not pay tax on it until you did your 2014 taxes in 2015.

This is all probably a bit complicated and should be probably be avoided if it makes you uncomfortable or if there are issues at your work that would make it a bad idea.

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
Re: When to exercise stock options?
« Reply #11 on: May 18, 2013, 06:19:18 PM »
Thanks Roland! I get it now. I appreciate the explanation and I see what you're saying. I like the idea of delaying the tax payment a year so it can be planned out. And I'm glad I asked about when to exercise because it sounds like everyone is saying to do it sooner rather than later. I guess I was thinking that I would lose money, but if I reinvest the $$, I don't lose it--just diversify more.

NealH

  • 5 O'Clock Shadow
  • *
  • Posts: 2
Re: When to exercise stock options?
« Reply #12 on: May 19, 2013, 06:14:17 PM »
IMHO:  Sell them when they vest.  Diversify away from your employer.

Thank you. So you think it's smarter to pay the taxes upon sale and then just reinvest into index funds or something? So let's say my options are worth $50,000 upon vesting. I pay income tax on the grant price and then 15% on capital gains. So then let's say it's worth $25,000 after taxes. It's still better to sell immediately and reinvest?

There are differences between Incentive Stock Options and Nonqualified Stock Options.  If you have Nonqualified, you pay tax on the spread at ordinary rates when you exercise and then you own the stock with a basis at FMV, so if you sell, no additional gain or loss.  With Incentive Stock Options, you pay no tax on exercise.  If you sell before the expiration of one year following exercise or two years following grant, you have a disqualifying disposition and you will pay tax on the gain at ordinary rates.  If you hold long enough to avoid a disqualifying disposition, you can sell and pay preferential capital gains tax rates.

With RSUs, the tax depends on whether you paid anything for them, when they vested, and whether you made an 83(b) election when you received them.  If you did not make an election, you are taxed as they vest based on FMV less amount paid (ordinary rates).  If you made the election, you would have been taxed at grant based on the then FMV over amount paid.  Once they vest, there is no additional tax hit, and you can sell at capital gains rates.

FlorenceMcGillicutty

  • Stubble
  • **
  • Posts: 116
Re: When to exercise stock options?
« Reply #13 on: May 19, 2013, 06:38:31 PM »
NealH, that's super helpful. Thanks! I have NSOs so I guess I won't have to pay gains or losses unless I hold onto them. Either way I have to pay ordinary income tax, so I might as well diversify away. At least that's what I think at the moment. Stock compensation is nice but it is really confusing.

As far as the RSUs, I didn't even know you could elect to pay taxes on grant. I didn't, and I fully vest in three years. I'm going to look into the 83(b) election you mentioned to see if it makes sense for me to do that on future grants. Thanks again.