When to Exercise Your Stock Options

Posted in May 3rd, 2009  Category:Retirement Planning

Employee stock options can provide you with a substantial source of
deferred income and permit you to control the recognition of taxable
income. You generally pay no tax when an option is granted because you
are not receiving any shares of stock, only the option to purchase
shares at a later date

In general, holding an option to acquire stock may be better than
holding the stock itself. The option provides protection against loss
should the value of the stock decline below the exercise price. In
addition, the option gives the holder equivalent ownership rights in
the corporation, without requiring any immediate investment. Employee
stock options offer the potential to have post-exercise stock growth
taxed as capital gains rather than ordinary income. This provides an
advantage for those who are in the top tax brackets

Know the Difference

Nonqualified Stock Options (NSOs) give an employee the option to buy
corporate stock at a specified, fixed price (usually at fair market
value at the time the option is granted). In general, you must exercise
your option to buy within a specified time period–typically 10 years or
less.

Upon exercising your rights, any gain realized from the spread (the
difference between the exercise price and the fair market value) is
taxed as ordinary income. However, any gain realized from the date the
option exercised until the date the stock is sold is taxed as capital
gain.

Incentive Stock Options (ISOs) also offer the option to purchase
corporate stock at a set price, but ISOs cannot be issued with an
exercise price below the current fair market value of the stock.

Generally, the spread on ISOs is not subject to ordinary income tax
at the time you exercise the option. However, spreads may be subject to
the alternative minimum tax (consult your GROCO financial adviser for
more information). Gain realized upon the sale of the ISO stock may be
taxed as capital gain. Provided you have held the ISO stock for at
least one year from the date of exercise and at least two years from
the date the option was granted, the entire gain recognized upon sale
of the stock is taxed as a long-term capital gain.

When to Exercise Your Options

The decision of when to exercise your options depends on several factors as well as your particular situation:

Your Company’s Plan

Generally, options become exercisable over a period of years. For
example, options granted in the company plan vest 20 percent a year
over five years. It’s important to know the details of your firm’s plan
before you make a decision.

Your Company’s Growth

Understanding how your company is poised for growth is another
important factor in your decision making process. Issues to review and
understand are:

• How your company makes money understand the industry that their earnings are tied to.



 



• Evaluate sales compare your companys sales to the industry average of competitors.



 



• Industry trends monitor the industry that your company operates
  in. Look for growth opportunities and understand your companys strategy
  for capturing market share.
  



 



• Understand the factors that can affect the liquidity of the
  market are lower interest rates and tax cuts freeing up resources for
  the companys growth plans?



 



• How your company is financing growth are they growing as expected?



 



• Know your leaders and their track record a companys strong executive team will likely yield continued success.



 



• Understand your companys P/E (price to earnings) ratio look for strong cash flow and well-managed costs.

Your Current Financial Needs

The decision to exercise should consider the need for cash, the
proximity to the option’s expiration and/or the current stock value as
compared to its expected future value. With regard to ISOs, because of
taxes, the required holding periods should be considered when
determining when to exercise the options and/or sell the underlying
stock.

Balancing Your Portfolio

You may also choose to exercise an option if your company’s stock represents a large

For more information on Know When to Exercise your Stock Options.

Posted by Dan Walter

Performensation: Equity Compensation for High Performance Companies.