This post will answer “should I exercise and hold my stock options?”
Our talking points will cover:
- What are stock options?
- What affects option price?
- Stock options vesting
- Stock option vs strike price
- Stock options tax treatment
- Best stock options for long term investment
- Stock options pros and cons
- How long can you hold a stock option?
- What happens when you exercise an option?
- Should I exercise my stock options as soon as they vest?
- Do I keep my stock options if I quit?
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If you’re unsure whether to hold your stock options, consulting for guidance could help and provide you with more details on specific questions you have in mind. Some of the possible questions we’ll try to discuss here.
What are stock options?
Stock options provide holders with the right to purchase or offload a stock within a specified time frame at a fixed price dubbed the strike price. Such right to buy or sell is optional.
Call options and put options are main types of stock options, which respectively grant the right to acquire and sell.
What affects option price?
An important factor is the stock price, since higher stock prices increase the value of call options.
Another crucial factor is the strike price, whereby call options with lower strike prices are more valuable. The remaining time before expiration also affects the option’s value, with a longer period typically translating into a higher option’s value.
Another important component is volatility. The higher level raises the possibility of notable changes in the stock price, which raises the option’s price. Options are also impacted by interest rates; higher rates generally translate into more expensive options.
Stock options vesting
The process through which an employee progressively acquires the right to stock options or equity awards issued by their company is known as vesting. Upon initial award, stock options usually do not belong entirely to the employees. Rather, the options exercise or vest over a predetermined time.
Before exercising your options, you must make sure they are fully vested.
Stock option vs strike price
The strike price of your option should be compared to the present market value of the stock. Your options have inherent worth and are in the money if the market price is greater. Your options are deemed underwater and may not be worth exercising if the strike price is higher vs stock value.
Stock options tax treatment
Certain tax benefits are provided by incentive stock options, or ISOs. The spread or the difference between the strike price and the fair market value is factored into certain tax calculations, although no taxes are levied upon the granting or exercising of the options.
Gains on the sale of shares are subject to long-term capital gains tax if they are held for more than 12 months following the exercise date and 24 months post the grant date.
The options are regarded as non-qualified, nonetheless, if these holding time conditions are not fulfilled.
NQSOs, or non-qualified stock options, function in a unique way. When exercised, the difference between the fair market value vs strike price is levied as ordinary income, and the employer usually deducts taxes from this amount. After that, any profits from the sale of the shares are subject to CGT.
What does exercising stock options mean?
When stock options are exercised, the right to buy business shares at a certain price is changed into actual ownership of said shares. This procedure entails paying the strike price, which is usually less than the going market rate, for the shares.
Best stock options for long term investment
Due to the fact that stocks with substantial price changes and large trading volume typically present better chances, substantial liquidity and volatility are essential for successful options trading. These include large-cap tech equities, such as Apple.
A large and active options market offering various strike price ranges and expiration dates is necessary for stocks to have a successful options trading strategy. Trader freedom and opportunity are increased with such. In addition to specific stocks, large indexes like the S&P 500 also see a lot of option trading activity.
Some stocks are favorable for options trading because of foreseeable triggers. A trader’s ability to place better educated bets on events can be enhanced by stocks that have obvious activities, which can alter the share price dramatically. A common triggering event is new product launches of tech giants that usually occur yearly.
Even though volatility is crucial, investing in highly volatile stocks can be dangerous because of the high probability of substantial losses associated with sharp shifts in prices. As a result, options techniques work best with companies that have mild to tolerable volatility.
Stock options pros and cons
Stock options benefits
- Options provide leverage which gives you significant upside potential if the stock price rises.
- You can protect your portfolio from a drop in the price of the underlying stock by buying put options.
- They provide you the autonomy to choose when to exercise options.
- You might qualify for advantageous tax treatment based on whether you own NSOs or ISOs.
- You are still eligible to profit from any future increases in the price of the business’ stock as long as you hold the options.
- Instead of being compelled to exercise your options right away, holding them gives you the freedom to do so whenever it suits your particular financial backdrop.
Stock options disadvantages
- Options are subject to the so-called time decay, which is the process that makes them lose value as they near their expiration date.
- An options’ worth can fluctuate materially owing to their great sensitivity to price swings. You can sustain significant losses if the stock price swings against your position.
- Options expire on a finite date, at which point they lose all of their value if they are not exercised.
- Poor management can result in large losses.
- It might be difficult to initiate and exit positions at advantageous prices with certain options because of their huge bid-ask spreads.
Should I exercise and hold my stock options?
You can purchase stock at the strike price by exercising your options. If you think the company will succeed, you can hang onto the shares or sell them right away for a profit.
Whether to sell or hold onto the shares depends on certain things, including the prospective growth of the company and the impact on taxes.
How long can you hold a stock option?
The time interval between the acquisition and exercise or sale is known as the stock options holding period.
Although stock options can often be held for up to a decade, the best time to sell them depends on their particular nature and your tax circumstances.
What happens when you exercise an option?
Upon exercising an option, you will purchase the underlying firm stock at the pre-established strike price specified in the option contract. You must pay the strike price per share x the quantity of shares you are buying in order to complete the exercise.
When shares are exercised, you own the shares you bought, and the holding term for those begins on the day of the exercise. The fact that stock options will eventually expire should not be overlooked. The option becomes worthless if it is not exercised prior to its expiration.
Should I exercise my stock options before IPO?
If stock price increases significantly after IPO, exercising options prior to the offering can result in large tax savings.
You can wind up paying too much for shares that are hard to sell and are not liquid if you exercise your options before the firm goes public or if the stock price ends up not rising.
The cost and taxes might be high, so you need to be sure you have enough money on hand.
Should I exercise my stock options as soon as they vest?
It may be advantageous tax-wise to exercise your stock options as soon as they vest and to start the holding period for possible capital gains. But there are significant risks associated with it as well, like stock market volatility, difficulties with liquidity, and the potential for losses should the business suffer or your job ends abruptly.
Do I keep my stock options if I quit?
You usually keep your vested stock options even if you quit your employment, but you have to take immediate action. You usually have ninety-days to use them before they expire. Subject to the conditions specified in your agreement, any options that have not vested as of your resignation will be seized.
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Adam is an internationally recognised author on financial matters, with over 760.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.
