Some posts in the past week piqued my attention but one I’d like to highlight is an article by The Simple Dollar. In this article, Trent has a reader with a question: should he keep his stock options? Well this post really hit home for me as options are a common form of compensation around here. I believe Trent pretty much nailed how one should go about deciding what to do:
If it looks like there’s still significant gas left in the tank for the company itself to grow, hold the options for now. You should wait until the instant your gut begins to tell you that the skyrocketing is slowing down or is over, then exercise the options and sell the stock.
There are also some thought-provoking comments to this post which added more perspective to this conundrum. Of course, I had to join in with my own response which I’m posting here:
If you already have a diversified portfolio and the options are tied to a strong public company like Google, then keep them. Even if it constitutes a huge portion of your net worth. Why do I say this? This is a once in a lifetime opportunity to score. You can multiply your net worth a ridiculous number of times by just sitting on options. Of course, if your assets are all riding on this one position then it would be a mistake not to diversify out of it. It’s worth keeping an “almost free” (something given to you outright) concentrated position in a hot stock/company if the rest of your finances are already in order.
Options are great because they are available to you at usually an incredibly low or no cost depending on the type it is. It’s such a great deal that you can consider it as having “windfall status” — of course, it’s a windfall that you’ve earned by virtue of being part of a company that wants to share its future with its employees.
If you’re sitting on options that have some value, you’re in a fantastic place and have a good problem in your hands! For every option package that actually is worth something, there are easily tens of them that turn out worthless. Being in this boat can be pretty nerve-wracking at times as your stock bobs and tumbles, but in my mind, there are a few methods you can try to help you decide whether to cash in or hang on.
A Few Ways To Handle Stock Options
By gut feel.
Whether you should exercise and redeem it all, partially or not at all — it’s all about weighing risk based on your personal situation. Being an “intuitive” type of investor means listening to your gut and measuring your risk tolerance. How comfortable are you with your overall situation? You’re an insider so you may be able to sense how things are going with your company better than anyone else. What does your gut tell you?
By approaching it analytically.
There are also other means you can try to help you make this decision, including one that provides you more analysis such as explained in this piece by Political Calculations’ Should You Keep or Sell Those Stock Options? With some simple mathematical calculations, you can figure out how your stock options stack up to alternative investments. If your options fall short, then you can consider selling them.
By hedging.
If you find yourself actually lucky enough to have accumulated a serious amount of paper money, then you may look into other avenues on capturing or locking some amount of profit. By discussing your plight with reputable financial institutions, they may be able to go over scenarios with you and offer hedging strategies you can apply because with employee stock options of a certain amount, more interesting wealth preservation strategies abound. And with that kind of money, there won’t be a shortage of financial reps that come knocking on your door once they catch wind of your “problem”.
And finally, if you do succeed in making out like a bandit with those options, make sure you read up on another article by The Simple Dollar that discusses how to deal with your multi-millions.
For more information, you can check out this CNN Money series on employee stock options. Best of luck to any of you facing this enviable dilemma.
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{ 8 comments… read them below or add one }
I just hope I get to work at a place that offers stock options (or at least work my way high enough in my current job to be offered them). There are a lot of easy ways to work the system and make money off of them as you mentioned here.
I’m not a believer in gut instincts unless they are based off of your research and facts.
with that said, you should review your portfolio periodically. This will mean that you do cash in stock options in order to limit your exposure. if it’s good enough for board members to do it, then it should be good enough for you to do it as well.
@Eric: Good luck with your job hunt. Startups and younger/smaller companies tend to have those option packages. Usually, the larger the company, the more paltry is the package and only top level executives make off with the loot.
@Tim: I agree with you that periodic sales of options is a good idea in order to alleviate risk. But sometimes, greed just takes over and wants you to sit on that n-bagger longer. That’s something we all need to learn to fight and control, but I’ve sure seen it work for a few people!
silicon VB, i agree on the greed portion. the key is to have a plan for your investments and periodically re-evaluate your positions. People have this notion that thinking in the long term for investments means you don’t have to actively manage your portfolio. this is why many people have lost their wealth during major downturns. you can sit on the n-bagger as long as you want, but you should have sell triggers along the way. this reduces your losses or protects your assets. i get the sense that people think long term investing means not selling.
One additional point is some companies offer you early-exercise packages. That is, you can actually buy the stock itself before it’s fully vested. This is good if you’re in a pre-IPO startup with a low strike price, but you expect a “monetization event” fairly soon, such as the IPO or a buyout. Buying the stock early means your gain from the monetization event will be a capital gain and not ordinary income, as long as you buy the stock at least a year in advance.
Lazy Man,
I just read your post that links to this one and I just had to echo your mention of MyStockOptions.com. This is indeed a handy reference to bookmark for those of you who will be receiving or are already hanging on to ESOs. I wish I could’ve perused this while we still had ESOs to worry about!
Thanks again Lazy Man :)!
Thanks for the plug above in comment #6 for myStockOptions.com. We have calculators and content to help you see the upside and downside of waiting to exercise and to prevent mistakes. The site also covers other types of equity grants, such as restricted stock and employee stock purchase plans.
We recommend you “stress test” your stock options. Play around in our Quick Take Stock Options calculator (in free and premium versions) to see what happens when stock price and tax rates go up and down. You can see your net proceeds at different prices and tax rates to get a feel for what you can tolerate on the downside and what you want on the upside.
Bruce Brumberg, Editor
mystockoptions.com
By the way, making the mistake of selling your options or your position in a company way too early can cost you dearly. Just check out this story of how one of Apple’s original cofounders ended up selling his Apple position for a mere $800.