Personal Finance & Money Asked on April 25, 2021
I work for a small company and was granted some stock options with a strike price of about $2.50. Now that the company has gone public, the stock prices hover between $15 and $20.
I’d like to get peoples thoughts on what the best time is to exercise these options? I believe that the stock price will go up further in the medium to long term future.
The options expire in 2031, so I have time to decide when I want to exercise them. My goal is to minimize the amount of tax that I pay on the transaction (exercise + sale). I have no immediate or near term need of these funds. I’m currently in my 30s and plan to retire by 2030 after my house is paid for.
My current marginal tax rate is 45%, which is why I’m hesitant to exercise now. The thought process is that it might be better to exercise these options in a leaner year when I’m perhaps not working or between jobs.
I do understand that it’s not a good idea to time the markets and that is not my intention. I’m just trying to weigh the pros and cons of exercising now and paying a higher income tax on these now and capital gains taxes when I sell or to defer the taxable event to later to have a larger income but at a lower tax rate.
The best time to exercise in-the-money options is when the stock is at its highest price and you are in your lowest tax bracket (unemployed or retired?). Good luck figuring out when that date will occur.
The pros and cons of exercising are fairly simple. If you exercise now, pay the taxes, and the stock tanks, you win by not losing. If you don't exercise then you win or lose based on what share price does.
At $20, $2.50 strike price options have a nice gain. I live in a world of protecting profits and if your now public company offers exchange traded options, I'd take a look at doing that. Here's an interesting story about Mark Cuban's Genius Trade: Protecting $1.4 Billion.
Given the potential for assignment and subsequent taxes, if options are available and you like this idea, consider doing this for a portion of your gains.
Answered by Bob Baerker on April 25, 2021
The thought process is that it might be better to exercise these options in a leaner year when I'm perhaps not working or between jobs.
In order to accomplish this you will need cash. You will have to buy the options, at the strike price, when you leave the company. Do you have the cash to cover such a transaction?
Now obviously you could do this without cash, exercise the options in January and quit in February and not work the rest of the year.
What percentage of your portfolio are we talking about here? It is pretty risky to have a large percentage of your wealth wrapped up in a single stock. For this reason, many people pare down their options and use the proceeds to fund other investments. Paying off your home is a great counterpoise to these options as it is a very conservative strategy.
When I had options, I always tried to exercise half of what became newly vested.
Answered by Pete B. on April 25, 2021
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