Many C level clients are entitled to receive company stock (options) from their employer as part of their remuneration package. Such stock options are viewed as complex call options on the common stock of a company.
Which raises several questions from optimization perspective:
A] What Exactly Are Stock Options?
Stock options are contracts which give an employee the right to buy or exercise a set number of shares of the company stock at an often pre set price. Which is called the ‘Grant Price’.
The employee has a limited amount of time to exercise his options before they expire and lose their value. The employer might require that the employee exercises his options within a period of time after leaving the company.
The number of options that a company will grant its employees varies. It depends on the company and on the seniority of the employees. Investors have to sign off before any employee can receive stock options.
B] Granting And Vesting Of Stock Options
The contract will specify the ‘Grant Date’. This is the day the options begin to vest. Which means that it is available for the employee to exercise and buy stock.
Most employees will not receive all of their options right away when they join the company. The options often vest gradually over a period of time known as the ‘Vesting Period’. Often this period amounts to four years.
As the options vest gradually over the course of the vesting period, the employee will be able to access a part of his stock options before those four years are up.
Often there is a one year waiting period before any of the options vest. The employee will need to stay with the company for at least one year to receive any of his options. Often he can vest each year 25%.
C] How To Exercise Stock Options
Once options vest, the employee has the ability to exercise them and buy shares of the company. Until then, they do not have a real value.
The price that the employee has to pay for those options is set in the contract. It is often called the ‘Grant/Strike/Exercise Price’. Regardless of the performance of the company, this price will not change.
An alternative approach besides buying the stock is to make an ‘exercise and sell’ transaction. Thus the employee buys the options and immediately sells them again. Rather than having to use his own money to exercise, the brokerage firm handling the sale will effectively front the money.
A different approach is an ‘exercise and sell to cover’ transaction. Thus the employee sells just enough shares to cover his purchase of the shares and hold the rest.
Please never forget that after the expiration date, the options have no value. So don’t be late.
D] When To Exercise Stock Options
It is obvious that when the stock is listed, that the employee should only want to exercise his options if the market price of the stock rises above the agreed upon exercise price.
Please be aware that in general the options are not transferable and there is no obligation for the employee to exercise the options, in which case the options will lapse.
E] Tax Planning: When To Vest?
To have the lowest possible tax exposure, you first need to know:
- The amount of the entitlement and its periodicy;
- The legally allowed/required moment of vesting;
- The price of vesting.
The next step is to look at the current tax regime to see if there are certain specific tax rules that might effect your tax exposure.
A well known example is that if you have the Dutch 30% Tax Ruling (which decreases your tax exposure), then it is best to vest as much as possible within this decreased tax rate.
F] Investment Planning: (When) To Sell?
Once you have the company stock, the next question is to see if or how it fits into your overall Portfolio.
There are several aspects to take into account:
- What is your Personal Risk Profile?
- Does equity fit into your profile and if so to what extent?
- What is your Investment Horizon?
- How long is it responsible to keep the stock in your Portfolio?
- What is the risk exposure of that specific stock? Higher/lower than average?
- You are aware that to have one type of stock increases risk substantially compared to investing in an Equity Fund with much better spread?
- Is a possible future market disruption and stock price drop to be expected and acceptable?
Please have your own plan about:
- How long you wish to go for the expected increase of value;
- Which risk you expect;
- Which risk you deem acceptable;
- As of which age you need to reduce your portfolio risk.