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Company Stock Options/ESPP Strategy
Old 04-17-2009, 11:09 AM   #1
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Company Stock Options/ESPP Strategy

My husband started a new position recently and part of his package is some Restricted Stock Units (RSUs) - which vest over 4 years - and the ability to participate in the Employee Stock Purchase Plan (ESPP) - max. of 10% of salary bought with 15% discount.

So for people who have participated in such plans what was your strategy to make this work for you? Reason I ask is years ago I had a similar offer with an employer and it ended up costing us money because the old greed monster took over. We had well and truly drunk the cool-aid and were not able to be objective about what was happening.

The amounts involved are not likely to be life-changing unless the stock goes up ten-fold, however I think that is unlikely seeing it has done that over the last 5 years and it is probably fairly priced. However, it would be a nice bonus to take every year.

We don't own any stock in the company so we do not have all our eggs in one basket. So should we sell the shares purchased in the ESPP as soon as they hit our account every six months?

I would be interested in hearing different successful strategies that people have used to manage these holdings as we are the poster children for doing it wrong in the past.
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Old 04-17-2009, 11:13 AM   #2
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The attractiveness of a discounted ESPP depends on the ability to immediately turn around and sell the stock on the open market, locking in a 15% profit (plus or minus).

If you have that ability, there's virtually no "company stock" risk if you do this every six months. If you don't, the usual caveats about loading up on your employer's stock apply (Enron, Enron, Enron...)

My employer's ESPP itself places no holding period requirements, but the company imposes a trading blackout window that means we can't sell for 2-3 weeks after buying the stock. Given that we get a 15% discount or more, it's a good calculated risk to take (in general, the stock won't tank 15% in 2-3 weeks) but it does add some risk. That's why I only put about 3% of pay into mine; if there was no trading blackout window and I could flip the shares right away, I'd probably be plowing 10% into it...
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Old 04-17-2009, 01:13 PM   #3
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I participate fully in ESPP and immediately sell the shares once they hit the account, which is 2-3 days after the period ends. In my case, it's easy money. If you have the same option, then I'd recommend the same.

I used to hold company shares, but many years ago I decided I didn't want to hold any individual stocks, include company shares, so I sold them all.

I never ran the numbers, but I'm guessing that if I put it into my AA instead of holding the shares, I would have come out ahead. Of course, that depends on the company, but it's not something I'd risk.
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Old 04-17-2009, 01:15 PM   #4
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I would be interested in hearing different successful strategies that people have used to manage these holdings as we are the poster children for doing it wrong in the past.
I participated in an ESPP plan for 16 years and tried several approaches. Initially we were offered an automatic quick sale option, i.e., stock was immediately sold. I was quite content to take the 15%, actually more since price 85% of lower of price on day 1 or day last of six month period. Then I got greedy. (I saw co-workers who thought the stock price would only go up and sit tight as the price fell from $60/share to ~$2/share -- ouch.) I learned my lesson and reverted to selling immediately. In spite of this I was under water twice before I could sell. The first time our genius senior management decided to announce the CEO's retirement in the early AM beforer the market opened on the day we purchased stock. The 15% evaporated. The 2nd time decided to do a reverse stock split and trading was suspended for 2 weeks. Once again 15% down the drain.
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Old 04-17-2009, 01:55 PM   #5
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I get RSUs, ISOs and I participate in the ESPP. So far I have just been accumulating company shares, though they still represent a small fraction of my portfolio (large number of shares, but low share price right now). But I never include company stock in my retirement calculations. It's my crazy, swing-for-the-fence money. Pure gambling. These days the share price is really low for a variety of reasons, though I am still (barely) in profits territory because my cost basis is even lower. But should the share price revert to the mean it would allow me to FIRE immediately.

So either: 1) the stock goes down from here and I still get to FIRE on schedule or 2) the stock goes up from here and allows me to FIRE sooner.

Either way, I think it's a risk I am willing to take.
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Old 04-17-2009, 02:16 PM   #6
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ESPP is a good way to accumulate company stock in an automated way at a discounted price. However, the need for the stock should be the starting point. It usually makes sense for folks with lower incomes and not much available $ or options to invest.

RSUs are not all the same. Will they be paid in shares or $$, and are they scaled or subject to some company goal?

One thing to always keep in mind with company stock is the added risk it carries - losing one's job and investment if the employer has a crisis.
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Old 04-17-2009, 02:21 PM   #7
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When I had the similiar ESPP plan, I put in the max allowed and sold it as soon as allowed to after the purchase (normally 2-4 days). Most of the time this is an automatic 12-17% gain.

For the RSUs/options, I just consider that as part of compensation and have been holding those more, and just don't bother to hold any of my company's stock in 401k other than the RSUs and options. They are a tougher situation though, since do you want to sell as soon as they vest, or is worth waiting? And this'll depend on the dollar amount and comfort level with the company.
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Old 04-17-2009, 02:49 PM   #8
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As some have mentioned.... being able to SELL is important....

My old company (not there anymore), you could sign up to buy the share for the next year... BUT, if you sold any shares from the account (and I mean ANY, even if bought in prior years) they would stop your purchase for the rest of the year...

SO, you would have to request that they send you a stock certificate... deposit it into a brokerage account.. wait until it shows up on your stock listings and THEN sell... for 15%, I would take the risk... for the 5% I got I still took the risk and it paid off well for the stock I sold... not so well for the stock I kept...
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Old 04-17-2009, 02:57 PM   #9
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How about a different picture......?

I was very aggressive. I went to work for a small startup which became a healthy medium-sized company and I stayed with them for 18 years. I bought all my incentive stock options before the grants expired (this was way before the company became public) and held on to the stock, and participated in the ESPP program pretty aggressively when it became available after the company went public many years later. I didn't divest from my company stock until within a year of I retiring (well, I did use a little bit 2 years prior to pay off my house). About the time I retired I did same-day-sale type exercises of any remaining unexercised options. The year I retired I sold around 2/3 of my company stock that I had owned for a long time, and another 20% the next year.

What can I say - I got lucky and this is why I was able to retire early. The year I was ready to retire, the company stock was at an all time high and maintained the high (and higher) the next year. It went through periods of being cut in half, but would usually reach new highs within another year or two. Basically, you were rewarded for hanging on.

Also - the initial money invested in company stock was never a huge percent of my savings. I still had considerable other savings and investments and continued to save aggressively. However, the company stock gradually grew to dwarf my other investments. I never saw this as that risky because it wasn't as if I had invested all my savings in the company. The additional risk of working there while having a huge net worth tied up in the company never bothered me either although it did motivate me to pay off the house. The fact is, this kind of concentration of investment is one way of hitting it out of the ballpark. But the key was that I was an early employee in a startup and knew our business and environment well, I was relatively young (time to recover), had no debts and no children. I was also darned lucky!!!

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Old 04-17-2009, 04:36 PM   #10
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I also accumulated a lot of company stock which allowed my early retirement. Looking back I took on too much risk at one point 80% of my net worth was tied to company stock.

Still I think automatically selling all company stock is being too risk adverse. In many cases (ESPP, Incentive stock options, and some restricted stock) there are significant tax advantages to holding on to the stock for a year (two in the case of ESPP). The difference between a Fed+State tax of ~35-40% for short term gains, vs ~18-22% Fed+state tax for long-term gain is significant. In fact, I argue that automatic selling of ESPP roughly halves your expected long term return.

Instead I think keeping 2 years of ESPP stock to get favorable tax treatment is a good. Once the most favorable tax treatment is achieved than go ahead and sell the stock, knowing that next batch of stock is just around the corner.
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Old 04-17-2009, 05:35 PM   #11
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Instead I think keeping 2 years of ESPP stock to get favorable tax treatment is a good. Once the most favorable tax treatment is achieved than go ahead and sell the stock, knowing that next batch of stock is just around the corner.
I agree that it can be, but that requires some risk tolerance. Even those with a low risk tolerance can lock in nice immediate gains (even if taxed as ordinary income) by quickly selling -- if they can immediately flip when the shares are purchased.

Those who aren't over-concentrated in company stock and who can accept the risk might do well to hold for two years.
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Old 04-17-2009, 06:43 PM   #12
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I agree that it can be, but that requires some risk tolerance. Even those with a low risk tolerance can lock in nice immediate gains (even if taxed as ordinary income) by quickly selling -- if they can immediately flip when the shares are purchased.

Those who aren't over-concentrated in company stock and who can accept the risk might do well to hold for two years.
I don't think we are disagreeing much, but lets put some numbers in.

Let say you make $100K/year and your ESPP allows you to put in 10% of your salary and get a 15% discount and every 6 months buy stock.

Alternative 1 is every 6 months sell stock typically worth due to the discount from 5,750 - $7,000 give 1/3 of the profits to the government and then do what with the money? Invest it right? Assuming a fairly aggressive 60 to 80% equity AA you are still taking on a significant amount of risk. Because of the tax bite, I think itis roughly equivalent to investing in a load mutual fund vs a no load. The upfront expense matter over the long term. Sure you are taking on company specific risk vs market risk, but plenty of MegaCorp have a Beta below 1.

Alternative 2 is to keep two years of stock. In most situations (i.e "normal" market) the total amount of company stock is $20,000 -30,000. For somebody in there 30s or 40s this should hopefully be in the 10% range of their total investments. Now once your company stock exceeds ~20% of your liquid net worth than I think diversification is more important than lowering your tax bill.
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Old 04-17-2009, 06:56 PM   #13
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As far as ESPP, it is worth holding to get favorable tax treatment ("qualifying disposition"). It is not a flat 2 years though, the formula is more complicated: the sale has to be a year after purchase *and* 2 years after the offering period.

As far as RSUs, I sell on vest although I confess to sometimes doing a bit of market timing of my employer's share price. I am holding some vested RSU shares now...

As far as options, this is the most complicated one since you are destroying the time-based portion of the option value on exercise. One way to look at it is that if you have 1000 nonqual options at $30 for a stock that's valued at $40, and exercise, you get say $6000 after tax. If you bought another $40 stock with that money you'd only have 150 shares. Better to let the 1000 options ride, in most cases, since you get the expected cap gain as if you had $40,000 in the market. There is research indicating that most employees exercise options far too early. My personal rule of thumb is to exercise periodically to diversify any time in the money value of vested options are more than say 3% of our net worth, but only when the 5-year time value is significantly smaller than the in the money value. mystockoptions.com is a good resource.
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Old 04-21-2009, 09:12 PM   #14
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As far as ESPP, it is worth holding to get favorable tax treatment ("qualifying disposition"). It is not a flat 2 years though, the formula is more complicated: the sale has to be a year after purchase *and* 2 years after the offering period.
For a typical 6-month program, the additional holding period is 18 months. I don't think it's worth holding for the tax benefit because it only takes a 3% change in the stock price to completely wipe out the tax advantage. Who can say any company's price won't drop by 3% over 18 months?
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Old 04-21-2009, 11:21 PM   #15
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For a typical 6-month program, the additional holding period is 18 months. I don't think it's worth holding for the tax benefit because it only takes a 3% change in the stock price to completely wipe out the tax advantage. Who can say any company's price won't drop by 3% over 18 months?
If I learned one thing the last year is that nobody can say with any certainty that a stock price won't drop 3% within 18 minutes much less 18 months. But you know what? The same thing can be said of the market as whole on many trading days the last year.

It is a question of comparative risk. If the plan is to sell the stock and stick the proceeds into a money market or CD fine. But all to often people who are nervous about holding the company stock for 18 months, are perfectly ok with investing in tech stocks, emerging market funds, aggressive growth funds, rental properties, taking out a HELOC, a bigger house, oil, gold, precious metal etc.

Because of tax advantages holding the company stock provides a higher expected return and in many case lower volatility than the alternative investment.
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Old 04-23-2009, 07:23 PM   #16
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I don't think it's worth holding for the tax benefit because it only takes a 3% change in the stock price to completely wipe out the tax advantage.
Our ESPP documents mention a tax advantage, but don't tell you what it is. What is the advantage of holding?
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Old 04-23-2009, 08:45 PM   #17
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You really need to read all the rules for ESPP's, they're really crazy. It was one of the first wierd tax situations I encountered, but not the last.

You may want to sell earlier or later depending on the stock price at the start of the 6 month offering period and the price at the end. Selling early triggers normal income tax rates on the difference between your buy price and the start or end price (I forget which). Selling later does the opposite. The rest of any gain is normal capital gains, depending on holding period. The normal income tax gain may or may not be added to your W-2 total income at the end of the year in which you sell. I've had it both ways. So read up and be careful.

I used to hold the stock when the price was low and the taxes favored a longer holding period. Sure, it could go down 15%. But it could go up 15% just as easily, and normally with a higher probability (stock prices do go up occasionally). If you do this often enough and your company doesn't just tank, you should be able to do a little better holding for longer periods. Just as long as it's a small part of your AA.
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Old 04-23-2009, 09:22 PM   #18
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Our ESPP documents mention a tax advantage, but don't tell you what it is. What is the advantage of holding?
This is from memory, I am not a CPA, and you shouldn't rely on tax advice from a stranger on an internet discussion board and you should read the Fairmark.com writeup. Those disclaimers aside, the tax advantage of ESPP are as follows.

A typical ESPP program works like this every 6 months (say Jan 30, and July 30) you enroll in a program and contribute x percent of your salary. At the end of the period you purchase stock at the lower of the Jan 30 or July 30 date, plus you get a 15% discount on the price. So if the stock price was $50 on Jan 30 2009 and went $60 on July 30 2009. You purchase shares at 85% * $50 or $42.50. If you sell ESPP stock before two years of the grant date any profit is taxed at ordinary income rates. Lets say you sell immediately, the profit in this case $60- 42.50 or $17.50/share would treated as ordinary income. (I am simplifying a bit here).

If you wait to sell until after Jan 30, 2011 all of the profit is taxed at the lower long term capital gains rate (generally 15%). Most but not all states follow the Federal rules. Of course the stock could have gone up or down in the 18 month since July 30, 2009 (when you actually bought the stock) so there is risk in following this strategy. But for a typical person the combined federal state tax saving is on the order of 15-20%. So in the example I gave it is between $2.60 and $3.50/share if the stock stays flat and more if it goes up.
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Old 04-23-2009, 09:57 PM   #19
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There are other arcane rules. You cannot purchase more than $25k "worth" of stock annually. No it is not based on the price on the strike date. I was in a plan where the price was set at 85% of the lesser of the price on day1 or day180. However, the limit was based on the day1 price. I believe this is an IRS rule. The stock price dropped significantly during the 6 month period and this limited the number of shares which could be purchased. Of course this is only an issue if you think the stock is still a good value.

I also inadvertently got a lesson in wash sales. I placed a limit order to harvest a tax loss. The limit price was hit 15 days after the purchase date of of the most recent 6 month cycle. Bingo, I had a wash sale and had to defer my loss and then trick TT to calculate my gain/loss in a subsequent year.
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Old 04-24-2009, 09:18 AM   #20
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This is from memory, I am not a CPA, and you shouldn't rely on tax advice from a stranger on an internet discussion board and you should read the Fairmark.com writeup. Those disclaimers aside, the tax advantage of ESPP are as follows.

A typical ESPP program works like this every 6 months (say Jan 30, and July 30) you enroll in a program and contribute x percent of your salary. At the end of the period you purchase stock at the lower of the Jan 30 or July 30 date, plus you get a 15% discount on the price. So if the stock price was $50 on Jan 30 2009 and went $60 on July 30 2009. You purchase shares at 85% * $50 or $42.50. If you sell ESPP stock before two years of the grant date any profit is taxed at ordinary income rates. Lets say you sell immediately, the profit in this case $60- 42.50 or $17.50/share would treated as ordinary income. (I am simplifying a bit here).

If you wait to sell until after Jan 30, 2011 all of the profit is taxed at the lower long term capital gains rate (generally 15%). Most but not all states follow the Federal rules. Of course the stock could have gone up or down in the 18 month since July 30, 2009 (when you actually bought the stock) so there is risk in following this strategy. But for a typical person the combined federal state tax saving is on the order of 15-20%. So in the example I gave it is between $2.60 and $3.50/share if the stock stays flat and more if it goes up.
Actually there's always a piece that will be taxed as income. In your example, the discount calculated off $50 is income, which is $7.50. The other $10 can be turned into capital gains. So the additional tax benefit for holding antoher 18 months is only $1.50 - $2.00 per share, which translates into 2.5% - 3.3% of the $60 price you can sell at in July 2009. You are hoping your stock will match or beat your alternative investment. If it underperforms by 2.5% - 3.3% over 18 months, you lose all the benefits from holding. If it underperforms more, you become worse off. More on Fairmark:

http://www.fairmark.com/execcomp/espp/qualifying.htm
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