What to do with those Employer stock options

Minnesota is home to many large publicly traded companies like Best Buy, Target, General Mills, and United Health Group. Having these giant companies here in Minnesota means there are also a lot of employees. As part of their compensation structure these companies generally give employees the ability to purchase stock at a discount as well issuing them stock options. We can discuss what to do with the employee stock later, right now I want to focus on stock options as it is a little harder to figure out what to do with them.

Stock Options and their Value

Very simply, a stock option gives you the right to purchase (or sell) a stock at a certain price. So when we are talking about company stock options, you are given the right to purchase some of your company's stock at a set price (strike price). Options are valued based on their intrinsic value and the time until expiration. The intrinsic value is just the difference between the strike price and your company's stock price. As for the time value it is more valuable to have an option expire later as there is more time for the stock price and therefore option value to go up.

Are you able to exercise your stock options?

Generally when your employer gives you stock options they have a vesting period. This is typically 3 years or more. Your employer is rewarding you but they also want to make sure you stick around for a while. Therefore, if your options are not vested you cannot exercise them. If you leave your job you will more then likely lose your unvested options. 

You also cannot exercise your options if they are "out of the money." This means the strike price of your options is more then price of your company stock. For example if your Best Buy stock options have a strike price of $40 and Best Buy's stock is at $35 you would not want to exercise your options. Think about it, why would you use your stock option to purchase Best Buy stock at $40 when you could go into the market and purchase it outright for $35.

When do your options expire?

Every option has an expiration date. This means you have to exercise your options before this date or they expire worthless. Most companies have a mechanism in place to automatically exercise your stock options before they expire but you should check to make sure. This gets back to the "Time Value" of your stock options. Your options are more valuable to you the further they are from expiration because you have a longer time to wait for the stock price to go up.

Taxes?

Yes of course there are tax consequences of your stock options. What those consequences are is determined by the type of options. If they are non-qualified options (NSO) it begins when you exercise your options. There are two parts related to the tax-ability that you need to understand:

1. If your options were issued with a bargain element (Strike price was lower then the company stock price at the time you received the options) you will be taxed at ordinary income tax rates and have to pay payroll taxes.

2. Once you exercise your options you receive company stock. If you sell that stock right away you are subject to short term capital gains. If you wait a year before selling the stock you will receive favorable long-term capital gains treatment.

The other type of options you may have are Incentive Stock Options (ISO). These options are not taxed when exercised. Instead, you pay the tax only when you sell the company stock. If the shares are sold right after exercising the bargain element is still taxed at ordinary income rates but you will not pay any payroll taxes. In order to achieve the favorable long-term capital gains you need to hold your stock for at least 12 months after you exercise and for at least 2 years after your options were initially granted to you.

Don't be too tied to your company's financial future.

So you are a Target employee. Your wardrobe is all khaki and red. You own some Target stock, Target Stock Options and Target RSU's. Not only do you have 20%+ of your portfolio connected to Target stock your paycheck comes from Target as well! While Brian Cornell would be proud of you, there are a lot of risks in having a majority of your wealth tied up with one single company. The stock market will never go to zero but a single company can and it happens all the time (Enron, Worldcom, Washington Mutual etc.). I'm not trying to pick on Target, I'm only trying to get the message across that you should diversify and exercising your options might be a good strategy to accomplish this.

Recap

First take a look at whether or not you are able to sell your options and when they expire. If you determine you are able to exercise them start looking at your overall investment portfolio. Consider how much exposure you have to your employer and think about what you would do with the money after selling the options. Don't forget to consider taxes. You don't want to be surprised by a large tax bill down the road.

Want an analysis of your company's stock options?  Reach out. We'd be more then happy to help you out with your specific situation.