Managing For and Around Employee Stock Options

Of the many challenges that face individual investors, one of the most complex is how to manage the stock options that one may receive as a part of either one’s compensation directly or as a part of an employee stock option plan. Whether you are seeking a san jose investment adviser or a san francisco financial advisor, employing an investment professional to aid in the process can be invaluable. Not only are the instruments themselves often complex, but the rules which govern how the employee may dispose of them are full of restrictions and intricacies that are important to understand. Trying to unravel these details can present a challenge, and because there are often time limitations, mistakes can be costly.

The Basics of Stock Options

In the most basic sense, a stock option gives the owner of the option the right to buy or sell shares of the underlying stock at a given price for a set amount of time. In the case of the options granted by employers, call options (those that allow the employee to buy the stock) are the only type used; put options (those that allow the holder to sell the stock at a specific price) are not used. While there is typically an active secondary market for stock options , meaning they can be bought and sold as options, many employee options have only two choices: they may be exercised and the stock can be purchased at the specified price, or they may be allowed to expire. What this means for the employee who has been granted the options is that he or she must often have sufficient capital available to exercise the option – in other words, the employ must have enough money to pay for the stock that the option entitles him or her to under the contract specifications.

Managing Employee Options

Depending on the specific limitations that are associated with the given options, managing one’s option position can be complicated. In addition to the capital constraints mentioned above, understanding the timing of options is important. For example, if the option gives the employee the right to by the stock for a year at a given price, it is important to understand the transaction costs of exercising the options, buying the stock and then potentially selling the stock to arrive at a profit. This can involve both waiting periods, tax ramifications and commissions that are important to understand.

The other important factor to consider in the case of employee stock options in the impact they have on diversification within one’s portfolio. While it is common for an employee to have a concentrated stock position in the shares of his or her employer’s company, this position must be managed within the overall context of the portfolio. For example, a careful manager will limit a client’s exposure not only to a given stock, but to an industry and a sector. Practically, this means that any investment decisions made within the same industry or sector as the employee is employed in will be influenced. This can be important also, because the employee may possess material non-public information, so trades in competitors may be restricted as much as trades in the stock of one’s own employer.