Make Money: Exercise Your Employee Stock Options (2024)

FAQs

Make Money: Exercise Your Employee Stock Options? ›

Exercise your stock options to buy shares of your company stock, then sell just enough of the company shares (at the same time) to cover the stock option cost, taxes, and brokerage commissions and fees. The proceeds you receive from an exercise-and-sell-to-cover transaction will be shares of stock.

Exercising options presents opportunities to earn a profit, but there also are potential downsides to exercising options. Earn dividends from owning the underlying stock. Fees, taxes, transaction costs potentially could cancel out any profit. Sell the underlying stock for a profit.

It only makes sense to exercise your options if they have value. If they do, they're known as “in-the-money.” This happens when the strike price (or exercise price) of your stock options is lower than the market price of your company shares trading on the exchange.

When you exercise your employee stock options, you generally have a choice to do a cash exercise or a cashless exercise. With a cash exercise, the goal is often to maximize the amount of stock you hold.

Exercising options after vesting

You can usually only exercise vested stock options. After you hit your vesting cliff (that waiting period mentioned earlier), you should be able to exercise your vested options whenever you want (as long as you remain employed).

Employees that receive stock options as part of their compensation package will hope to exercise them one day in the future. Exercising stock options means purchasing the option stock granted to you at the exercise price , grant price , or strike price , which means you now own common stock of the company.

The most common reason for exercising is when you own call options based on an underlying security and you decide you actually want to own that underlying security. For example, you may have bought options on a particular stock, expecting that stock to go up in value.

Often, vested stock options expire if they are not exercised within the specified timeframe after service termination. Typically, stock options expire within 90 days of leaving the company, so you could lose them if you don't exercise your options.

Early exercise makes sense when an option is close to its strike price and close to expiration. Employees of startups and companies can also choose to exercise their options early to avoid the alternative minimum tax (AMT).

While an option seller will always have some level of uncertainty, being assigned may be a somewhat predictable event. Only about 7% of options positions are typically exercised, but that does not imply that investors can expect to be assigned on only 7% of their short positions.

What is the downside of employee stock options? ›

What are the cons of offering employee stock options? Although stock option plans offer many advantages, the tax implications for employees can be complicated. Dilution can be very costly to shareholder over the long run. Stock options are difficult to value.

Move Stock to an Individual Retirement Account (IRA) Exercise options in a Qualified Small Business. Minimize Medicare Taxes by Investing before an Exit. File an 83(i) Election to defer NSO taxes for 5 years.

If it's a company whose mission you can see carrying it places, more stock is a good way of making sure you get in on a good thing early. On the flip side, if you don't know enough to evaluate the business, or you're accepting the position as more of a career stepping stone, extra cash may be your move.

A cashless exercise, also known as a "same-day sale," is a transaction in which an employee exercises their stock options by using a short-term loan provided by a brokerage firm. The proceeds from exercising the stock options are then used to repay the loan.

The best decision is almost always selling the company stock as soon as possible and reinvesting the proceeds a balanced portfolio or a long-term investment strategy that maximizes your expected returns given the risk. Some experts recommend minimizing future regret rather than optimizing future returns.

If you leave your company voluntarily, either to retire, to take another job, or to take a break from work, you generally have up to 3 months or 90 days from your termination date to exercise your vested options. (As always, check your plan document as this period can be shorter or longer.)

Occasionally a stock pays a big dividend and exercising a call option to capture the dividend may be worthwhile. Or, if you own an option that is deep in the money, you may not be able to sell it at fair value. If bids are too low, however, it may be preferable to exercise the option to buy or sell the stock.

You don't need to exercise your options as soon as they vest. There are some legitimate reasons for waiting a bit longer to exercise. For example, you may have a ton of faith that the market price of the company stock will continue to increase over time.

Every stock option has an exercise price, also called the strike price, which is the price at which a share can be bought. In the US, the exercise price is typically set at the fair market value of the underlying stock as of the date the option is granted, in order to comply with certain requirements under US tax law.

According to Kar, time is the most crucial weapon for an option buyer. Typically, an option buyer should not hold the position for more than 3 days, because the time decay will eat into the premium. Kar also recommended retail traders to avoid buying options ahead of a weekend or a long weekend.

What is the $100 K rule for early exercise? ›

The ISO $100K limit, also known as the “ISO limit” or “$100K rule,” exists to prevent employees from taking too much advantage of the tax benefits associated with ISOs. It states that employees can't receive more than $100,000 worth of exercisable ISOs in a given calendar year.

The downside of early exercising is investment risk, as you have to pay the exercise price (and, perhaps, some taxes at exercise) out of pocket before you have any visibility into whether the value of the shares will go up.

When the stock price equals the strike price, the option contract has zero intrinsic value and is at the money. Therefore, there is really no reason to exercise the contract when it can be bought in the market for the same price. The option contract is not exercised and expires worthless.

This means that the only time you can exercise your contract is the last trading day (usually Friday) before expiration. Even though there is only one day to exercise your contract, you can always close out your option position in the market on any day prior to expiration.

American options can be exercised at any time up to and including the expiration date of the option. However, European options can only be exercised on the date of expiration. Options can expire either in the money (ITM) or out of the money (OTM).

Restricted Stock Unit Grants: This is the most popular type of employee stock plan for many startups. Restricted stock units (RSUs) provide several of the features described above including a vesting period of how long the employee must work for the company to access a certain amount of stock options.

You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.

Employee stock options represent a right that you have to exercise your options and receive your stock, but not an obligation. There is value in employee stock options when the market price is higher than the grant or strike price, but while you might make a lot of money off of them, you also might not.

You report the taxable income only when you sell the stock. And, depending on how long you own the stock, that income could be taxed at capital gain rates ranging from 0% to 23.8% (for sales in 2022)—typically a lot lower than your regular income tax rate.

Since you'll have to exercise your option through your employer, your employer will usually report the amount of your income on line 1 of your Form W-2 as ordinary wages or salary and the income will be included when you file your tax return.

How to avoid getting double taxed on employee stock purchase plan? ›

They can only report the unadjusted basis, or what the employee paid for the stock. To avoid double taxation, the employee must make an adjustment on Form 8949. Warning: Do not use the box labeled “1g Adjustments” on Form 1099-B to make this adjustment; that is for something else entirely.

The best option in a majority of cases, as stated by Jeff Rose, a certified financial planner, is to give employees cash compensation that they are comfortable with and add stock options on top. This way, there is no real cost to the employee in terms of reduced salaries.

Stock options are a popular way for companies to build a strong relationship with employees and to motivate them to work hard in the interests of the company. Stock options are also a way to encourage employees to stay and not be tempted to leave and work for a competitor.

Out-of-the-money options perform better with a substantial increase in the price of the underlying stock; however, if you expect a smaller increase, at-the-money or in-the-money options are your best choices. Bullish investors must have a good idea of when the stock will hit their target price—the time horizon.

The bottom line on ESPPs

If you can afford it, you should participate up to the full amount and then sell the shares as soon as you can. You might even consider prioritizing your ESPP over 401(k) contributions, depending on your specific financial situation, because your after-tax returns could be higher.

Best Day of the Week to Sell Stocks

If Monday may be the best day of the week to buy stocks, then Friday may be the best day to sell stock—before prices dip on Monday.

Unfortunately, in most cases, if you're laid off and your stocks are still unvested, you'll likely lose them. They will revert to the company, and you'll receive no benefit from them.

As an option approaches expiry, the contract holder must decide whether to sell, exercise, or let it expire. Options can be in or out of the money. When an option is in the money, it can be exercised or sold. An out-of-the-money option expires worthless.

With a repurchase right, a shareholder owns the stock that is subject to repurchase. When stock options are vested, the option holders do not have any rights to the stock. A repurchase right gives the originating company the right to buy back the sold stock from the shareholders if certain conditions are met.

Review: Exercising your options

Only consider early exercise if you're a very early employee. Otherwise, the best time to exercise is when your company begins the process of going public. If your company is already public, only exercise if the exercise price is below the fair market value of the shares.

Should I exercise my stock options before acquisition? ›

If your startup is entering acquisition negotiations, it can be financially prudent to simply wait to see how the acquisition shakes out. The major benefit to exercising stock options pre-exit is to take advantage of long-term capital gains.

If the option is exercised, you still keep the premium but are obligated to buy or sell the underlying stock if assigned.

When you sell an option, you typically pay a commission. When you exercise an option, you usually pay a fee to exercise and a second commission to buy or sell the shares..

It may sound complicated, but accepting your stock grant should be a no-brainer for anyone who's starting at a new company. It's low-risk and can provide measurable benefits down the road. To get started on the ins and outs of stock options, check out part 1 of our series Equity 101: Startup Employee Stock Options.

When the time for the company to go public comes, the real question is how much do employees make in an IPO? You can make anything from a few thousand dollars up to millions. It depends on how successful the company is, the number of employees with equity, the type of equity you have, and the lock-up period.

If you plan to hold your incentive stock option shares after you exercise them, a lower stock price may be a perfect time to exercise. A lower stock price likely means you'll pay less AMT (as discussed above).

You don't need to exercise your options as soon as they vest. There are some legitimate reasons for waiting a bit longer to exercise. For example, you may have a ton of faith that the market price of the company stock will continue to increase over time.

As the holder of an equity or ETF call option, you can exercise your right to buy the stock throughout the life of the option up to your brokerage firm's exercise cut-off time on the last trading day. Options exchanges have a cut-off time of 4:30 p.m. CT, for receiving an exercise notice.

Options traders can profit by being an option buyer or an option writer. Options allow for potential profit during both volatile times, regardless of which direction the market is moving. This is possible because options can be traded in anticipation of market appreciation or depreciation.