Just remember, the current stock price is where it’s at because that’s what everyone trading the stock believes it is worth.
Step 5 – Think When Should Your Exercise
Depending on the type of stock options, ISOs (incentive stock options) or NQSOs (non-qualified stock options), the decision to exercise can vary as each type of option has different tax consequences.
NQSOs are often awarded to non-employees (i.e., consultants) while ISOs are more often awarded to employees. ISOs also have less complex tax consequences than NQSOs. Because of this, this section will reference ISOs. If you’d like the full run down on exercising both types of options, check out this article: 6 Strategies to Exercise Your Employee Stock Options.
It’s important to know that whatever amount your stock options are worth will be different from the after-tax amount. It’s the after-tax amount you’ll want to consider as it’s the amount you’ll walk away with.
Once exercised, taxes will be owed on the gain between option grant price and the exercise price (known as the bargain element). This taxable gain will often involve the AMT. Downside market volatility can mean a lower bargain element and thus a smaller AMT hit for those exercising incentive stock options. In fact, if you are bullish in the stock, a downside price movement may be a good time to exercise and hold incentive stock options. At least from a tax standpoint. Check with your accountant about the details.
Ultimately exercising stock options means owing taxes, which can be significant depending on the gain. Plan ahead so you can cover this tax bill. You may want to pay it out-of-pocket or sell some shares and pay taxes using the proceeds.
Once you have paid your taxes, you’ll have shares of company stock in your brokerage account. Do these shares fit into your portfolio allocation? Are they compromising your long-term plan in any way? Would it be better to sale some of the shares and deposit them into your retirement plan?
As the value of your shares increases, it can distort any decisions about what to do with the shares. You may decide to hold longer for even more gain, all the while your portfolio has become overweight in company stock.
Step 6 – Remember Diversification When Volatility Strikes Your Company
Periods of stock price volatility can be a good time to review the benefits of a diversified portfolio. During volatility times, some assets will be up while others are down and some may even be flat. A mixture of asset classes can help so the entire portfolio isn’t down. There can be scenarios where overall your portfolio is down. But through diversification, some will be down less than others. But more often, it will be a mixed bag – with some assets up while others are down.
If you have a diversified portfolio in addition to your stock options, volatile periods are a time to review how each performs. Often, a diversified portfolio of assets may not have the same downside risk as does as individual stock position and may have held up considerably well.
If you find yourself without diversification, a volatile period can be a good reminder of why you may want to introduce this into the portfolio. If that is the case, an exercise and reallocation of some or all the stock options may be necessary. In fact, no matter how much your company stock is worth, how much you love the company, and how high you think it will go, diversifying is something that should at least be considered.
Related: From Intern to Employee
Step 7 – Don’t Invest Amounts You Cannot Afford To Lose
Most often than not, there’s very little reason to continue keeping a bundle of your assets tied up in one stock – whether it is your company stock or any other. In fact, concentrated equity is the opposite of diversification. More importantly, concentrated equity may mean that you are jeopardizing your financial future. And for what?
We discussed earlier the importance of having a plan and sticking it to it. Hopefully this plan has address not unknowingly investing amounts that you cannot afford to lose.
When volatility strikes, it’s a good time to review the plan and remember that the money you need is invested elsewhere, and the plan still works! This review of the plan should increase your confidence, allowing for you to keep you on track rather than reacting emotionally.
Even more, when volatility strikes, its nice to know that volatility is not impacting the money that you cannot afford to lose.
Related: Financial Planning for Employee Stock Options
Dealing with Volatility
Volatility and stock options go hand in hand. This is nothing new.
In fact, volatility can be good in that the it quickly means your stock options are worth considerably more than they were previously. Unfortunately, the opposite can happen too. Rapidly wiping away value. Unfortunately it is the ladder that has the ability to lead to bad outcomes.
This is why its so important to take notice of your stock options and develop a plan that consider taxes, but also your overall financial plan. A good financial plan, coupled with a continued reality check of where you are can lead to great outcome during the scary times of increased market volatility.
This article has been republished with permission from Daniel Zajac.