Most of us are more than willing to at least explore the tools at our disposal when it comes to amplifying wealth. Certain investments offer valuable opportunities for doing just that. Taking the time to understand exactly what stock options are available to you through your company can make a world of difference in your financial journey, especially with the guidance of a knowledgeable WealthCoach.

What Is a Stock Option?

In executive compensation packages, stock options are typically non-qualified and compensatory, and give you the ability to purchase shares of stock in the company at a discounted rate or fixed price. Knowing if and when you should exercise these options is a vital part of your WealthPlan. The benefits might seem obvious: Even as the value of the shares increases, you are able to purchase these shares at a specified price (the strike price). If the per share value of the stock is greater than the strike price, then the options are said to be “in the money.” For instance, if you hold a vested option for 10,000 shares that is already “in the money,” as each share value increases, your net gain increases exponentially, even though you have not yet paid anything for the purchase of the shares. On the other hand, if the per share value of the stock falls below the strike price, those options are considered “out of the money,” and the option may become worthless.

The Right Timing

With this understanding of the conditional value of your stock options, it becomes necessary to develop a strategy that you can employ when it comes to exercising them. You might choose to forgo exercising the option, holding onto it if you think the per share value of the stock will continue to increase. If you do decide to exercise the option, there are a couple of different approaches you may want to consider there as well. You can exercise the options while the share value is high, then immediately choose to sell the acquired shares; an option that seems best if you believe the share price is going to drop soon. Alternatively, you can hold on to the acquired shares once you have exercised, for potential future appreciation.

Opportunities and Obstacles

As with any WealthPlan, you must keep in mind that even once you have a strategy in place, often roadblocks or circumstances brought on by individual experience might have an effect. If your option requires that it be exercised before the lapse date occurs, it may have to be at a less than optimal share price. Blackout dates or minimum holding requirements can limit your ability to exercise these options. Sometimes monetary issues can also impact exercising options. The strike price is due immediately and income tax will generally be due on the difference between the actual value of the stock and the price paid.  It is often possible to cover these cash needs by the sale of some shares of acquired stock in a “cashless” exercise, resulting in the ownership of fewer shares, or it can be paid with other resources or borrowed funds, which leaves the investor with more acquired shares.

Just as income tax is generally due on the difference between the strike price and the exercise price, once the resulting shares are sold capital gains tax rates apply on the difference between exercise price and sales price. This depends on how long the share is held, as well as your adjusted gross income at the time. If a cashless exercise occurs, in which the shares are sold immediately, typically no capital gains tax is applied. However, if the share is held for over a year, the gain could be taxed a long-term capital gains tax rate once it is sold.

As new layers of annually granted options are added, each with a new number of shares and a different strike price, the question of how and when to exercise your stock options becomes more complex. Paying attention to company options and plans, as well as checking in on your own financial health, can help you make the most of your opportunities.

About Tom Kirk, FirstWave Financial

Tom Kirk is the founder of FirstWave Financial and a WealthCoach. He is also the creator of The WealthCare Solution and The Retirement Plan Optimizer, and transforms the complexity that wealth brings into simplicity and confidence for clients.