A BMB Reader writes:
Have you seen any good articles or recommendations on exercising (employee) stock options? Many advisors recommend leaving the options as long as you can in the account and to cash them before expiration. Others say you can cash the options to pay off your home.
BMB did a quick web search and came across a web site that seems to have a great deal of information on the subject of options and taxes. For most employees, they’ll need to check out the information on non-qualified stock options. He also encourages the reader to do as much research as they can about the subject before making any decisions.
As for our recommendations, there is one very simple one: Maximize your profits.
How does one maximize profits from the exercise of employee stock options? In BMB’s mind, there are two major factors that will determine your profit: stock price and taxes.
- Stock price — track your company’s stock price, and understand where it is from a historical perspective. Take a look at the longer term charts (you can view long-term charts at sites like Bigcharts.com). See if the stock price is trending higher or lower - what has it been doing over the past few years - has it moved at all? What are the prospects for the future for the company and for the industry it’s in (and don’t necessarily believe what the company is telling you…)? If the stock is doing well, by all means, don’t rush to exercise your options. But if the stock has been lagging, you might want to think about taking some of your options off the table the next time it rallies. There is no reason to hang on to options until expiration if they’re only going to decrease in value.
- Taxes — pay attention on this one, for this is something you may not know: Your profit from the exercise of employee stock options (in most cases) will be taxed as ordinary income, NOT as a capital gain. In the year of your exercise, the profit you make on the exercise of your stock options will be added to your regular income for the year, which may very well push you into a higher tax bracket (which effectively decreases your profit on the options). This is true if you have non-qualified stock options (most common) as opposed to incentive stock options. Know what type of options you have, so you can understand the tax consequences. You may even consider exercising your options over time instead of all at once to minimize the tax burden. It all depends on your individual circumstances.
Know the numbers, know the facts, and know your individual situation.
As for what to do with the money after you exercise, BMB certainly has no problem with the idea of putting the money toward payment on your house (making sure the mortgage company credits you with payment on principal). There really isn’t a surer way of saving 5-10% on your money than by paying off mortgage debt. And for the future, consider how much less income you could get by on if you didn’t have a mortgage and/or auto loan payments. Certainly something to think about, especially if retirement isn’t too far off.