ESPP with 6 month lockup - still a good deal?

[Beaker]

My employer just started offering an ESPP (Employee Stock Purchase Plan). There are a number of threads discussing these (1 2 3 4 5, there are more), with the general consensus being that they're free money. However, all of those had no lockup period, so you could sell the shares on the day they were granted and pocket the discount with no risk. My plan has a restriction on selling the shares for six months after they're granted, so I have to absorb some risk of the stock dropping during that period. Of course it could rise too, but I'm not going to pretend I know what one stock will do over such a short period.

Plan parameters
Contribution/Buy-in Period: 3 months
Share Discount: 15% from prior day's closing price (no lookback period)
Selling restriction/lockup: 6 months from date of purchase
Stock Dividend Yield: 0.92%

I have two questions:
1) Is it worth throwing money into this plan, despite the 6 month lockup?
2) Is there some reasonably cheap way to offset the risk of the stock dropping during the lockup period? I saw selling covered call options mentioned on another thread, but I don't fully understand that or if it would be worthwhile.

[Interest Compound]

This is one of the least advantageous ESPPs I've seen, however it still might be worth it. Does the stock typically fluctuate 15% in 6 months?

[Beaker]

Does the stock typically fluctuate 15% in 6 months?

It's not that unlikely.

According to Yahoo Finance the beta is 1.21, so it's more volatile than the market overall. The 52-week high is nearly double the 52-week low, and the current price is about 22% below what it was 6 months ago.

[neil]

Think of options as insurance.  If you are selling calls, you are actually taking on risk (and getting a premium in return), not the other way around.  The premium gives you a small buffer on the downside, but you are still taking on all the risk and none of the reward.  Options are expensive to buy for insurance reasons, and they can generally only be bought/sold in lots of 100 shares and expire on specific dates unrelated to your lockup period.  Another thought is to directly short, but you will have to pay interest to the lender for six months.  The interest is not deductible in the same way capital losses are, and you pay ordinary tax rates on ESPP gains, so I doubt this is a good option.

Without doing the exact math, you are still getting ~25% CAGR at the cost of locking up cash for 6-9 months and holding 6 months of contributions at any given time.  That is still a pretty significant compensation you are giving up if you don't do it.

Consider:
- Portfolio size of 6 months of contributions versus the rest of your portfolio.
- This is money destined for the stash and not needed for some other purpose
- Avoid playing games with the share price when you lose money

It's easy to get in the market timing business when you are regularly trading shares.  For the most part, this will only give you heartburn.  I personally tried valuing shares and holding when the price was low, but that resulted in about five years of accumulation and a big tax bill at the end.  I would have been much happier banking capital gains in index funds I have no reason to sell.  It's important to remain robotic if you choose to go in because you probably won't win if you try to "repair" losses.  You might feel better avoiding the occasional mark in the "loss" column, but it's mostly superficial if the reason you got back level was due to a market run and not anything specific with your company stock.

If you look at most stocks over long periods, they usually follow the market except during periods of truly significant events, but there is a lot of noise on the way there.  Obviously there is no guarantee of future returns, but you can test out the volatility using prior data to see how often it works out (though you should be comparing to an index and not whether the trade itself was positive or not) and try to gauge whether you are fine with that personally.

Most of the reason not to do this will either be behavioral or company specific.  You'll have to make a call, but you should probably either commit to doing it or not.  Stepping in lightly and then giving up after a 50% drop is pretty much equivalent to buying high and selling low.

[seattlecyclone]

I don't know anything about your employer, but this seems like a bet where the odds are in your favor.

All you have to do to "win" is have your employer's stock not lag the market by more than 15% over a period of six months.

You will lose this bet fairly often, but over a sufficient number of six-month periods you'll almost certainly come out on top overall.

In general, when you see a bet where the odds are in your favor, and losing the bet would not be catastrophic, take the bet!

[Interest Compound]

If maxing out the ESPP doesn't represent a huge % of your portfolio, I'd do it. Even if it was 100% of your portfolio, after you sell the first round, it'd drop down to half of your portfolio. Yea, either way I think I'd do it.

[Beaker]

...you should be comparing to an index and not whether the trade itself was positive or not...

All you have to do to "win" is have your employer's stock not lag the market by more than 15% over a period of six months.

This is a key point that I had missed, and quite relevant since my alternative destination for the cash is Vanguard funds.

In view of that, and that it will be a small percentage of the overall 'stash, I'll probably put some money into it. Thanks folks.

[Beaker]

I talked about this some with a more knowledgeable relative, who pointed out that the easy way to neutralize the risk is to short the stock. I just reread the ESPP agreement, and this doesn't seem to be forbidden anywhere that I can see.

So basically on the grant date, I short an equal amount of shares. On the date that the lockup releases, I sell the shares and cover the shorts. My exposure to the stock is completely neutralized and I get to pocket the plan discount, minus the cost of the short.

[seattlecyclone]

My employer has a general policy against short selling or trading options backed by company stock. Make sure your company doesn't have a similar blanket policy defined outside the ESPP agreement.

[redcedar]

This is one of the least advantageous ESPPs I've seen

I may be able to beat that plan for least advantageous but I guess that is not a goal to be proud of (end in a preposition!).  My company offers 15% match, contribution limit 3-7% based on years with the company, purchases made with each paycheck so 24 times a year, EACH with its own 6 month required holding period. So no look back and a perpetual 6 month holding period as long as you participate. Bonus of 24 cost basis amount to worry about as well. Yippee!

[Livewell]

I would only do espp that you can sell same day. 

My view, and this comes from watching the dot bomb up close, is you sell any rsu, above water option or espp same day and move that found guaranteed money into the broader market (index fund, etc).

If your company does well, you will get more pay and more of all the stock benefits.  You're already leveraged for upside in company X, take some money off the table as you can.

Good luck!

[not_a_trex]

Are the stocks purchased at the time of paycheck or at the 6 month interval mark?

I ask because one of my previous employers locked up the money from each paycheck for up to 3 months and then purchased the stock at the end of the quarter. So I had the stocks for a very short amount of time and was then able to turn it around the next day and sell immediately, pretty much locking in the ESPP bonus (plus or minus a day's fluctuation).

[FINate]

I talked about this some with a more knowledgeable relative, who pointed out that the easy way to neutralize the risk is to short the stock. I just reread the ESPP agreement, and this doesn't seem to be forbidden anywhere that I can see.

So basically on the grant date, I short an equal amount of shares. On the date that the lockup releases, I sell the shares and cover the shorts. My exposure to the stock is completely neutralized and I get to pocket the plan discount, minus the cost of the short.

If you're worried enough about the risk to attempt a hedge then I would skip the ESPP. It suggests either or some combination of: 1) high risk aversion, and/or 2) lack of confidence in company's future. Shorting the company you work for is generally considered bad form, and as other people have pointed out, your employment agreement or other company policy may disallow this.

In your shoes I would start with a very small amount, get into a systematic rhythm of buying small amounts and then selling above-water shares as the lock-up expires. Whatever you do, put a hard limit on % of your portfolio you will own in company stock, which should be small. The last thing you want is to be laid off and simultaneously have a huge drop in your stash. 

[MustacheAndaHalf]

I talked about this some with a more knowledgeable relative, who pointed out that the easy way to neutralize the risk is to short the stock. I just reread the ESPP agreement, and this doesn't seem to be forbidden anywhere that I can see.

Aren't you risking the SEC deciding that you traded on inside information?  Consider their perspective: an employee suddenly shorts their own company stock, having never shorted any stock before.
https://www.sec.gov/answers/insider.htm

Have you searched your employment agreement?  They probably don't allow shorting the company stock there.  If you work at a company, and you short the stock, you are betting on your employer to fail.  You are creating a financial conflict of interest.  You gain money if your employer's stock gets worse, and your employer counts on you to help make the stock go up by your work.

[seattlecyclone]

Ethics of shorting the stock aside, keep in mind that by doing so you are reducing your expected return by any interest and fees you need to pay to keep your short position open.

Reread my original reply to this thread. Take small bets when the odds are in your favor, even if there's a significant probability of losing. Do this enough times and you'll certainly come out ahead in the long run compared to if you habitually "play it safe" by paying for short sale fees, extended warranties, low-deductible insurance, etc.

[Ursus Major]

For me it would depend on how you feel about your company's protects. I did an ESPP with my company for several years. They also had a 15% discount and no lockup period, but I just kept accumulating shares for years. I did this between 1999 and ca. 2005. In the end I came out ahead, but only because the stock dropped so much during the shot com bust that I accumulated ridiculous amounts of shares. And then later it recovered, not to the 2000 level, but enough to make it a net positive for me.

Today I probably wouldn't participate in that plan, unless I thought it was a good investment, independent of the discount.

[money_maniac]

Don't short your company stock- not only is this unethical and probably in violation of employment/ESPP agreement- it could be construed as insider trading.

Simply sell 6 month calls equal to the strike price (not including the 15% discount) of your ESPP buy in. You'll lock in your 15% discount and snag a little bit of option premium as well.

Buying puts won't be economical, but they'll allow you to keep all the upside with no downside risk (did I mention that'll be expensive?). Buying puts is also one step closee to shorting since if you knew your company stock was going down, you'd buy puts and could sell at a tidy profit once said company stock did go down.

[Beaker]

My employer has a general policy against short selling or trading options backed by company stock. Make sure your company doesn't have a similar blanket policy defined outside the ESPP agreement.

Good advice, I am looking into that.

This seems unethical.

I don't understand why it would be unethical. Since I would be simultaneously long and short, I would be net neutral about the future of the stock. I would not make money from any stock movements in either direction. Where's the ethical conflict?

Aren't you risking the SEC deciding that you traded on inside information?  Consider their perspective: an employee suddenly shorts their own company stock, having never shorted any stock before.
https://www.sec.gov/answers/insider.htm

I'm a small enough fish that I'm officially Not An Insider according to the company. If I had other information the insider policy could still apply, but that would be the case for either long or short positions. Heck, it would even apply when I went to sell the shares from the ESPP. In any case, I doubt the SEC is going to have time or energy to go after someone for a net-neutral position that amounts to low-five-figures per year.

...by doing so you are reducing your expected return by any interest and fees you need to pay to keep your short position open.

Take small bets when the odds are in your favor, even if there's a significant probability of losing.

It would be reducing the return, probably by around the 1.25% that Vanguard charges for margin accounts. The net seems almost like a 6-month CD paying 13.75%, which I would buy all day long if I could. You would prefer the risk of a single-stock position to that?

Simply sell 6 month calls equal to the strike price (not including the 15% discount) of your ESPP buy in. You'll lock in your 15% discount and snag a little bit of option premium as well.

But if the stock dropped from the ESPP buy-in presumably the calls wouldn't be exercised, and I'd still be holding the shares at a loss. On the flip side, if the stock rose then the calls would be exercised, and I'd be out the gain. Am I missing something here?

[FINate]

This seems unethical.

I don't understand why it would be unethical. Since I would be simultaneously long and short, I would be net neutral about the future of the stock. I would not make money from any stock movements in either direction. Where's the ethical conflict?

Aren't you risking the SEC deciding that you traded on inside information?  Consider their perspective: an employee suddenly shorts their own company stock, having never shorted any stock before.
https://www.sec.gov/answers/insider.htm

I'm a small enough fish that I'm officially Not An Insider according to the company. If I had other information the insider policy could still apply, but that would be the case for either long or short positions. Heck, it would even apply when I went to sell the shares from the ESPP. In any case, I doubt the SEC is going to have time or energy to go after someone for a net-neutral position that amounts to low-five-figures per year.

It's unethical because it creates a conflict of interest. As an employee you are there to add value, not negative or no net value (as in the case of hedging your ESPP against losses). Furthermore, it's not clear to me that you could structure a hedge in such a way that you never gain from a loss in shareholder value. You may see it as hedging a long position, but the regulators may not have the same point of view. However low you are in the company, you are an employee and are therefore an insider.

I wouldn't assume that the SEC ignores the little players - they are the government and don't behave with typical business like efficiency by only going after the efforts with the biggest returns. What happens if the company you work for implodes for some reason and you're left in a very valuable short position? Looks bad. I don't think it is worth it.

I agree with https://www.quora.com/Can-I-short-my-companys-stock - "This is a legal landmine and you could be in trouble even if you had no insider information when you shorted your own company."

[seattlecyclone]

...by doing so you are reducing your expected return by any interest and fees you need to pay to keep your short position open.

Take small bets when the odds are in your favor, even if there's a significant probability of losing.

It would be reducing the return, probably by around the 1.25% that Vanguard charges for margin accounts. The net seems almost like a 6-month CD paying 13.75%, which I would buy all day long if I could. You would prefer the risk of a single-stock position to that?

If my life savings were on the line, I would take the guaranteed 13.75%. For a small portion of my net worth? I would pick the volatile investment with an expected 15% return every time.

It's the same reason why it's a good financial move to buy insurance for your home, but paying extra to have a low deductible so that insurance pays out for every little thing is not a good move. Some years you'll experience some minor damage where you would have been better off with a low deductible, but most years you won't.

Sometimes your company stock will underperform VTSAX, other times it will outperform. Why not take the small risk for the larger expected return? Take small risks throughout your life and you'll get to FI that much faster.

Edited to add: I think you're reading Vanguard's margin rate table wrong. It's really a 7.75% interest rate for balances under $20k, or 3.88% over six months.

[Beaker]

It's unethical because it creates a conflict of interest.

I can see the conflict if I held a net-short position. I still can't see it for a net-neutral position.

Everyone seems to agree that selling the shares as soon as I can is perfectly ethical, up to and including selling them the instant they're granted if I was allowed to. I'm not clear on the ethical distinction between that, and neutralizing the exposure with shorts. In both cases I wouldn't stand to make or lose money regardless of whether the stock went up, down, sidewise, or took up bungee jumping.

As an employee you are there to add value, not negative or no net value (as in the case of hedging your ESPP against losses).

You seem to be equating my exposure to the stock with adding value as an employee. This line of reasoning would seem to imply that selling the company stock, or even just not holding any, would also be unethical.

Edited to add: I think you're reading Vanguard's margin rate table wrong. It's really a 7.75% interest rate for balances under $20k, or 3.88% over six months.

I was reading that wrong, thank you for setting me straight. That does dampen my enthusiasm considerably.

I understand what you're saying regarding the risk/reward. But I already have an investment plan that meets my risk/reward criteria and it does not include exposure to individual stocks. It really doesn't include exposure to stocks that I haven't researched at all. Hence why I'm trying to get the ESPP "free money" without taking on any extra risk.

[FINate]

It's unethical because it creates a conflict of interest.

I can see the conflict if I held a net-short position. I still can't see it for a net-neutral position.

Everyone seems to agree that selling the shares as soon as I can is perfectly ethical, up to and including selling them the instant they're granted if I was allowed to. I'm not clear on the ethical distinction between that, and neutralizing the exposure with shorts. In both cases I wouldn't stand to make or lose money regardless of whether the stock went up, down, sidewise, or took up bungee jumping.

As an employee you are there to add value, not negative or no net value (as in the case of hedging your ESPP against losses).

You seem to be equating my exposure to the stock with adding value as an employee. This line of reasoning would seem to imply that selling the company stock, or even just not holding any, would also be unethical.

I'm still skeptical that you could setup a purely net-neutral position, which means you potentially gain if the stock declines. If your company allowed you to sell ESPP stock immediately after grant that would be ethical because this would be considered common practice and the board approved of this.  However this is moot as your ESPP plan requires a lock-up period, so clearly they want you to take on some of the risk in exchange for the benefit of the 15% discount. As many people have stated on this thread, shorting your employer is not common, not recommended, may get you into trouble.

You don't have to convince me or anyone else here, you have to [potentially] convince your employer and/or regulators. Laws and regulations are not always logical (eg our tax code) so don't get too convinced by how reasonable the idea may seem.

[Beaker]

You don't have to convince me or anyone else here, you have to [potentially] convince your employer and/or regulators. Laws and regulations are not always logical (eg our tax code) so don't get too convinced by how reasonable the idea may seem.

No arguments that the laws and company rules are what they are. I just don't understand the ethical argument, but a lot of people made it so I'm wanted to figure out if I was missing something there.

In any case, it turns out that there is a company policy against shorting, which includes any sort of derivative or option that functions similarly. So I can't do it.

Nonetheless, interesting discussion all around. Thanks to everyone for the input and comments.

[FINate]

No arguments that the laws and company rules are what they are. I just don't understand the ethical argument, but a lot of people made it so I'm wanted to figure out if I was missing something there.

Laws and regulations aside let's focus on the ethics of your specific situation. Your ESPP w/ lock-up is clearly designed to ensure that participants have skin in the game, which is without doubt done as a way to align your interests with that of the company's - so that you have an incentive for the company as a whole to do well so that you also benefit.  Placing a bet against the company to hedge away this risk would be an attempt to gain the value of the ESPP discount without the intended incentives. Even if company policy did not disallow shorting the company, I would consider this unethical.

[MustacheAndaHalf]

I'd recommend searching for "conflicts of interest" and your company name to see what documents come up.  Here's an example from Apple's code of conduct (from a search result):
"In addition, employees are prohibited from investing in derivatives of Apple’s securities. This includes, but is not limited to, trading in put or call options related to securities of the company."

[Beaker]

[Your ESPP w/ lock-up is clearly designed to ensure that participants have skin in the game, which is without doubt done as a way to align your interests with that of the company's - so that you have an incentive for the company as a whole to do well so that you also benefit.  Placing a bet against the company to hedge away this risk would be an attempt to gain the value of the ESPP discount without the intended incentives. Even if company policy did not disallow shorting the company, I would consider this unethical.

If I understand you correctly, your objection is essentially that I was trying to "game the system", or violate the spirit of the law while following the letter. I see your point, but a couple of things occurred to me.

Gaming the system is a pretty common thing, and practically a hobby for some people around here. Tax minimization, Social Security claiming strategies, travel hacking, credit card churning - pretty much all of those are gaming some system to extract as much value as possible while giving up the least possible, and I don't think most people consider them unethical. Although I think most would agree that there's a difference between, say, allocating investments to minimize dividend taxes and the whole Double Irish thing that some multinationals were involved in. Somewhere in between those points it goes from being ethical tax minimization to unethical tax dodging. It seems to me that there a similar continuum here. Nobody has a problem with selling shares ASAP, and pretty much everyone thinks that being net-short your company is wrong. You seem to think my proposed shorting strategy falls on the wrong side of that continuum, but I'm not convinced of that.

Also, it's generally considered a bad idea for employees to hold very much exposure to their employer's stock, because they already have a huge exposure to their employer's risk through their job. A graphic example of that is the Enron blow up, when many employees saw their savings, held as Enron stock, evaporate at they same time they were lost their jobs. By encouraging employees to hold company stock, the company and ESPP are arguably encouraging employees to act against their own best interest to the benefit of the company. Since that doesn't seem terribly ethical to me, I have little ethical problem with trying to sidestep it.

Obviously I don't totally agree with you, but I don't totally disagree either. Thanks for giving me something to think about.

[dogboyslim]

Leaving ethics aside, I don't think I'd be worried about the SEC and insider trading if you can show a consistent strategy of shorting to hedge.  If you only short when you win, you will get a hard look.  If the company implodes and you look like a winner, but have a history of the trading pattern and times when it was a loser, I'm pretty sure you won't have to worry about jail.  That doesn't mean you won't get investigated and have to deal with that.  Personally I would only participate if I did the buy-hold the 6 month strategy.  The only benefit we have of purchasing stock through the company is that the transaction has no fees and it can come right out of the paycheck.  I still buy a small amount with each paycheck and over a few years I almost have a balance worth considering a part of my portfolio!

[Jack]

I realize it's a moot point for the OP since he isn't allowed to short by company policy, but in theory you could reduce the risk while keeping on the right side of the ethics / conflict of interest issue by shorting only part of your position -- say, 50-75% of it.