How to exercise stock options?

Stock options are now a part of most companies’ employee compensation packages. Sometimes, the employees receive them and wonder how to put them to use in the real world. It can be complicated because we have never been trained on using them or what strategies to follow when exercising them. A comprehensive knowledge of employee stock options and how to put them to use can help remove the fear around the concept. This article aims to do just that! Keep reading to know more.

Employee Stock Options

Some companies allocate a certain number of shares to be exercised by their employees, which can be part of their compensation or incentive structure. This right to exercise company stocks is called the Employee Stock Options Plan. It mainly focuses on attracting and retaining deserving talents for a longer time. The benefits that come along with the scheme will urge them to be more loyal to the company and ensure extended association.

The employers usually offer the workers the rights to company stocks at a discounted price compared to the market value.

The stock values will increase over time based on the company’s ability to perform in the following years.

The employees will have specific requirements to meet before exercising their rights. For example, there might be a vesting period that they have to serve to be fully eligible to exercise their stock options.

Stock Options Types

Based on the company’s strategy, stock options can be either Incentive or non-qualified. Usually, companies offer their employees Incentive Stock Options (ISOs). Once they sell the stocks for the current market rate, the employees become eligible to pay income taxes. On the other hand, companies offer directors, contractors, service providers, and consultants with Non-qualified Stock Options (NSOs). Participants can pay taxes once they exercise their right over these options. The tax value depends on the difference between the grant and current market prices.

Things to consider before exercising your options

Before exercising your stock options, you must have a few considerations. Firstly, make sure you have followed the vesting conditions.

Analyzing how the company is performing or growing in value is essential. These insights will help you decide if you should do the exercise immediately.

If the company’s value looks very promising in the future, you wait for it to rise and then sell the stocks. Getting professional guidance before exercising is better if the stock value is likely to drop. It is also crucial to be aware of the taxes you might be required to pay.

How to exercise your right over stock options?

The companies may have procedures and conditions which dictate how to exercise the options, and it’s essential to be familiar with them before proceeding. You can exercise your stock options in any of the following ways:

• Exercise and hold by paying cash — You can buy your shares using your money and wait for it to increase in value before you sell. Doing so is great if the company performs well in the future because you can turn your investment into profits. It can also be risky, mainly during cases where you buy more shares, hoping the value would increase, but the market value suddenly drops, or the company performs poorly. In such cases, you lose your cash.
• Exercise and sell by going cashless — In this case, you can purchase the shares that your company offers and sell them immediately. You can invest the cash you receive in other options you find helpful.
• Sell to cover — In these cases, the sales of the acquired shares will serve just enough to pay your commission fee, tax, and purchase price. The remaining shares will still be a part of company stocks.
• Stock swap — This option allows you to purchase new company stocks using the profits you gain by selling some of your old stocks. Swapping stocks is another cashless exercise of stock options and helps you avoid paying taxes.

When should you exercise your stock option?

You must be wary of the impacts your stock option exercising pattern has on your taxation or profit potential. Certain companies expect you to serve a vesting period or achieve specific goals before giving you access to the stocks.

• Exercise after vesting — Vesting is acquiring your right to exercise the stocks. If the company expects you to serve a cliff period, say two years, you can decide what to do with your stocks after that. This is valid as long as you are associated with the company.
• Exercise when leaving the company — Most companies have an extended period to let you exercise your right to the stocks post-resignation. You can wait until this time if you see a potential increase in the company value.
• Exercise early — Some employers let you exercise options before they vest. Sometimes, early exercise can be a great idea as it relieves additional taxes and reduces the holding period.

Summing up

There is no perfect time to exercise your rights over stock options. It depends on the company’s potential and market trends. Figuring out how to analyze both may require professional guidance. If you need assistance understanding how vesting works or how to leverage stock options before expiry, Eqvista is the best place to start. Have more queries? Book a consultation call with us now!