Stock Options and Restricted Stock: Own a Piece of your Company

Stock options are a low-cost way for your employer to provide you with extra compensation while increasing your incentive to produce for the company. They give you the right (option) to buy stock in the company at a given price (the "strike price") for a given time (the "exercise period," typically up to 10 years).

For example, your employer grants you an option to buy 1,000 shares of your company for $40. The stock is selling for $45. You can exercise your option and immediately sell the shares. You have a $5,000 taxable gain, your company has a $5,000 tax deduction, and it costs neither of you a cent of your cash flow.

Better still, if you hold onto the option and the stock price rises, the company can get a very big tax deduction without cash outlay. (The employer can deduct the difference between the price of the option when given and the price when exercised.)

Meanwhile, it costs you nothing to wait. When the share price rises, for example to $88, you can exercise your option at $40 and immediately sell the stock for $88, pocketing a taxable $48,000.

Cash Flow Consideration

If you are lucky enough to be offered options, what you do may be determined by your cash flow at the time.

  • The no-cash turnover (either now or later): You do not have to actually pay for the shares when you exercise the option. If you simultaneously sell the shares you buy on the option, your broker will offset one against the other and you will receive only the difference (less commission, of course). You can do this anytime before the option expires.
  • Exercise the option, immediately: This will actually cost you money. You must buy the stock at the option price. Then hold on to the stock and sell it as you would any other investment.
  • Exercise the option, later: Again, this will cost you the same amount as if you did not wait, but you pay at a later date. So why wait? To see whether the price of the shares goes up. There is no risk to waiting; the cost to you is the same.

Dollar Cost Averaging and Stock Options

Dollar Cost Averaging and Stock Options

If you are having a problem deciding when and how to exercise your options, do it on a schedule. Exercise a fixed portion of your options at fixed intervals. In this way, you spread out your risk and your tax burdens. Always do a no-cash transfer and use the proceeds to buy other equities. This avoids having all of your eggs in one basket. It's a combination of averaging and asset allocation that won't let you down.

True Wealth
Stock options are incentives for you to work for a company. They are also often offered to a sales force as bonuses for hitting sales goals. Like salary and other benefits, options are negotiable. They can be requested as a signing bonus, at raise time, in lieu of a raise or in addition to an unsatisfactorily small raise.

As with any other compensation, don't expect to sit idly by and have the benefit handed to you on a platter. Ask.

And be aware that some of your coworkers may have a better deal called "restricted stock." These are actual shares in your company that only become yours after a vested period. And you can usually only sell them back to the company (at the market price for listed stock, or at an agreed price for companies that have not gone public).

Restricted stock options are more like salary and do reduce a company's bottom line but are attractive because their cost, unlike cash bonuses and the like, can be spread out over the vesting period. For you it means no cash flow issues whatsoever. It is free stock in your company.
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