When to Buy Stock Options

burbo

Hey everyone, thanks in advance for any help.

So, my wife works for a well known internet start up and has been granted some stock options. This company seems to be doing well and we have every reason to expect that the value of the stock will increase over time. So, we would like to buy some of these stock options. I am just wondering when the best time is.

The agreement that they set along with it seems like it is pretty standard stuff, but I have never seen one before so I don't really know. Basically, there are a certain number stock options, and 1/48th of them become vested every month. Aside from termination, is there any reason to buy any of these vested options before you want to sell them? They will always be available at the price that the option was granted, correct? Even if the company goes public? So what is the advantage to owning them before you want to sell them, it seems like it just keeps your money tied up.

I hope this isn't an every situation is different and it depends on your agreement kind of thing, but I was hoping some of you have dealt with this a time or two before and have a basic reccomended course that people usually do, or could at least briefly explain some upsides and downsides to different courses of action. Thanks again.

localh77

Minor quibble, but the word you're looking for is exercise, not buy.

In general, yeah, there's no big hurry, and you can wait until you plan to sell the shares before you exercise the options. But there can be reasons to exercise them before you plan to sell them. One thing to keep in mind is that assuming that they're non-qualified options (and that's something that you should check, as qualified options are different), as soon as you exercise the options, you pay tax at regular income tax rates. And if the stock value increases before you finally sell it, you pay tax at capital gains rates. For example:

You're granted 100 options at $5/share in 2010. You exercise them at $10/share in 2012. You then sell them at $20/share in 2015. In this case, you'd pay tax on $500 of regular income in 2012, and $1000 of capital gains in 2015. If you're in the 25% tax bracket both years, that's $125 of tax in 2012 and $150 in 2015.

On the other hand, if you held the options until 2015 and exercised/sold the shares then, you'd have $1500 of regular income in 2015 which would be $375 of tax.

If you're not in the same bracket each year (or if Congress changes tax rates), that obviously complicates things. The point though is that there can be reasons to exercise them before you plan to sell them.

That said, when I had options, I just waited until I was ready to sell to exercise them. And depending on how value much we're talking about, it may not make a big difference.

devCharles

Honestly, some companies do it different from others, so I'd recommend asking a staff accountant at this specific company if possible, and they should be able to tell you what's up.

burbo

Thanks for the reply. I think in my specific case, the stock options are better than the non qualified options. Here is what is said about them in the agreement.

Exercise of ISO. If the Option qualifies as an ISO, there will be no
regular U.S. federal or applicable state income tax liability upon the exercise of the Option,
although the excess, if any, of the Fair Market Value of the Shares on the date of exercise over
the Exercise Price will be treated as a tax preference item for federal alternative minimum tax
purposes and may subject the Participant to the alternative minimum tax in the year of exercise.

I'm not really sure what the business about minimum tax is, but I'm hoping we won't be in a position to pay minimum tax any time soon.

But mainly, it sounds like you agree with me, that unless you aren't liquid enough to exercise your option when you want to, there isn't a super compelling reason to keep your money tied up in it.

JacksWastedLife

There's also the matter of long term capital gains. If you hold a stock for more than a year, you pay far less in capital gains tax than if you hold it for less than a year. This is an argument for exercising your options as they become available so that at the moment you are allowed to sell them because the company goes public, most if not all, will be eligible for the reduced capital gains.

SatanIsMyMotor

If she's vesting the options I'd simply wait. If the company is doing as well as you say there's a likelihood that somebody bigger will acquire them. If that's the case they will have to buy out any vested options. This has happened to me and resulted in a lot of money.

burbo

Thanks for the reply guys. I think that for now we will wait to exercise the options until there is a good reason (like, we want to sell them or something). Especially thanks for the ideas about tax implications.