{"id":1584,"date":"2014-11-05T08:38:49","date_gmt":"2014-11-05T16:38:49","guid":{"rendered":"https:\/\/addison.lwh.dev\/insights\/stock-options-what-they-really-mean\/"},"modified":"2014-11-05T08:38:49","modified_gmt":"2014-11-05T16:38:49","slug":"stock-options-what-they-really-mean","status":"publish","type":"post","link":"https:\/\/addisongroup.com\/insights\/stock-options-what-they-really-mean\/","title":{"rendered":"Stock Options – What They Really Mean"},"content":{"rendered":"\n

Congratulations! Your compensation package includes employee stock options. Now what? Understanding stock options and how they work can get pretty tricky \u2014 but you can master the topic. And because it involves money, particularly yours, it\u2019s a good idea to know what you\u2019re doing. Take a look through the information below and you\u2019ll be on your way to becoming an expert.<\/p>\n\n\n\n

Types of stock options<\/strong><\/h2>\n\n\n\n

Nonqualified stock options<\/strong><\/h3>\n\n\n\n

These are the stock options of choice for\n broad-based plans. Generally, you owe no tax when these options are \ngranted. Rather, you are required to pay ordinary income tax on the \ndifference, or \u201cspread,\u201d between the grant price and the stock\u2019s market \nvalue when you purchase (\u201cexercise\u201d) the shares. After that, any \nappreciation in the stock is taxed at capital gains rates when you sell.\n Keep the stock for more than a year and you\u2019ll have a long-term capital\n gain, taxed at a top rate of 20%; hold for one year or less and your \ngain is short-term, taxed at higher, ordinary income tax rates. \nNonqualified options can be granted at a discount to the stock\u2019s then \nmarket value. They also are \u201ctransferable\u201d to children and charity, \nprovided your company permits it.<\/p>\n\n\n\n

Incentive stock options (ISOs)<\/strong><\/h3>\n\n\n\n

These are also known as \u201cqualified\u201d stock\n options because they qualify to receive special tax treatment. No \nincome tax is due at grant or exercise. Rather, the tax is deferred \nuntil you sell the stock. At that point, the entire option gain (the \ninitial spread at exercise plus any subsequent appreciation) is taxed at\n long-term capital gains rates, provided you sell at least two years \nafter the option is granted and at least one year after you exercise.<\/p>\n\n\n\n

If you don\u2019t meet the holding period \nrequirements, the sale is a \u201cdisqualifying disposition\u201d and you are \ntaxed as if you had held nonqualified options. The spread at exercise is\n taxed as ordinary income, and only the subsequent appreciation is taxed\n as capital gain.<\/p>\n\n\n\n

Unlike nonqualified options, ISOs may not\n be granted at a discount to the stock\u2019s then market value, and they are\n not transferable, other than by will.<\/p>\n\n\n\n

Two warnings apply here:<\/strong><\/p>\n\n\n\n

  1. No more than $100,000 in ISOs can become exercisable in any year.<\/li>
  2. The spread at exercise is considered a preference item for purposes \nof calculating the dreaded Alternative Minimum Tax (AMT), increasing \ntaxable income for AMT purposes. A disqualifying disposition can help \nyou avoid this tax.<\/li><\/ol>\n\n\n\n

    Employee Stock Option Basics<\/strong><\/h2>\n\n\n\n

    An employee stock option is the right \ngiven to you by your employer to buy (\u201cexercise\u201d) a certain number of \nshares of company stock at a pre-set price (the \u201cgrant,\u201d \u201cstrike,\u201d or \n\u201cexercise price\u201d) over a certain period of time ( the \u201cexercise \nperiod\u201d). Most options are granted on publicly-traded stock, but it is \npossible for privately-held companies to design similar plans using \ntheir own pricing methods. Usually the strike price is equal to the \nstock\u2019s market value at the time the option is granted, but not always. \nIt can be lower or higher than that, depending on the type of option.<\/p>\n\n\n\n

    Employees profit if they can sell their stock for more than they paid\n at exercise. Most stock options have an exercise period of 10 years. \nThis is the maximum amount of time during which the shares may be \npurchased, or the option \u201cexercised.\u201d Restrictions inside this period \nare prescribed by a \u201cvesting\u201d schedule, which sets the minimum amount of\n time that must be met before exercise. Most options are fully vested \nafter the third or fourth year. Whenever the stock\u2019s market value is \ngreater than the option price, the option is said to be \u201cin the money.\u201d \nConversely, if the market value is less than the option price, the \noption is said to be \u201cunderwater.\u201d<\/p>\n\n\n\n

    When to exercise<\/strong><\/p>\n\n\n\n

    Conventional wisdom holds that you should\n sit on your options until they are about to expire to allow the stock \nto appreciate and, therefore, maximize your gain. But many employees \ncan\u2019t wait that long. One study found that the typical employee cashed \nout of his options within six months of becoming eligible to do so, \nthereby sacrificing an estimated $1 in future value for every $2 \nrealized. There are legitimate reasons to exercise early. You may have \nlost faith in your employer\u2019s prospects and, therefore, its stock. You \nmay be overdosing on company stock. It is unwise to keep more than 10% \nof your portfolio in employer stock.<\/p>\n\n\n\n

    Exercising stock options<\/strong><\/h3>\n\n\n\n

    There are three basic ways to exercise options: pay cash, swap company stock you already own, and engage in a cashless exercise.<\/p>\n\n\n\n

    Cash<\/strong><\/h4>\n\n\n\n

    This is the most straightforward route. \nYou give your employer the necessary money and get stock certificates in\n return. But what if, when it comes time to exercise, you don\u2019t have \nenough cash on hand to buy the option shares and pay any resulting tax?<\/p>\n\n\n\n

    Stock swaps<\/strong><\/h4>\n\n\n\n

    Some employers let you trade company \nstock you already own to acquire option stock. Say your company stock \nsells for $50 a share and you have an ISO to buy 5,000 additional shares\n for $25 each. Instead of paying $125,000 in cash to exercise the \noption, you could exchange 2,500 shares (with a total market value of \n$125,000) you already own for the 5,000 new shares. This strategy has \nthe additional benefit of limiting your concentration in company stock.<\/p>\n\n\n\n

    Cashless exercises<\/strong><\/h4>\n\n\n\n

    This is where you borrow from a \nstockbroker the money needed to exercise your option and, \nsimultaneously, sell at least enough shares to cover your costs, \nincluding taxes and broker\u2019s commissions. Any balance is paid to you in \ncash or stock.<\/p>\n","protected":false},"excerpt":{"rendered":"

    Congratulations! Your compensation package includes employee stock options. Now what? Understanding stock options and how they work can get pretty<\/p>\n","protected":false},"author":9,"featured_media":1585,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[109],"tags":[],"post_function":[],"post_audience":[],"class_list":{"0":"post-1584","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-recruiting"},"acf":[],"yoast_head":"\nStock Options - What They Really Mean<\/title>\n<meta name=\"description\" content=\"Your compensation package includes employee stock options. Now what? 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