Stock Options as a percentage of investable assets - what's too high?

[Toocold]

I've been fortunate to work at a stable megacorp where the stock price has had a nice run up, and I'm sitting on a decent chunk of change of in-the-money fully vested stock options.

My worry is that they now represent almost 20% of investable assets, and it will go up to 25% once the next traunch becomes vested early next year. This is uncomfortably high for me.

Add to this is that if I exercise my options, it will be taxed at the highest marginal tax rates, and I feel I already pay enough taxes to Uncle Sam.

Has anybody else been in this situation? Any advice on how to manage this?

 

[ERD50]

It is high, but not sky-high for a stable megacorp, and taxes are a factor.

A couple things to consider, may or may not be worthwhile:

Buy some puts, to protect against a big loss. Go down far enough and it shouldn't cost too much. Less than taxes I'd bet.

Short some % of the stock - this will need to backed by cash or other stock, or pay margin rates, and you miss out on any gains (other than divs).

-ERD50

 

[TeeRuh]

I was lucky enough to have some pretty good options (and some not so good $0) from MegaTech. My approach was:
a) Did not consider option value in my AA at all. i.e.; Never treated it as part of my nest egg.
b) Held all of them for full 10 years. I've been retired for 6 years and I think I have two more years of using cashed options to cover living expenses. i.e.; I have yet to draw down from my nest egg.

YMMV,
t.r.

 

[tennisno1]

I'm in a similar fortunate experience...

In general I felt uncomfortable having my salary, bonus and a big percentage of my next worth (stock) all tied to my company. I entered into a planned trading plan with a range of price targets I was comfortable with and never looked back. I de-leveraged over time... my view is tax planning is important but not the #1 issue.

Some other reasons I cashed out the in the money options: I also get stock in traunches and was still receiving more each year. If I want I can buy additional stock at a discounted price through an employee stock purchase plan.

Food for thought: Some one asked me what was my sell price target and I really did not have one. They also asked me how much was I willing to let the stock go down before I sold or would I just ride the up and down paper dollars for ever? It was a nice way of saying to me I did not have an exit plan! Also, if someone told me 10 years ago my stock would grow to X dollars would I be happy and sell.. that answer for me was yes.

Finally- it got me to FI faster... paid off mortgage, kids through school and invested in a good ole total stock low cost index fund and am targeting march 2016 to RE... good luck with your decisions

 

[Senator]

Start selling the options a little at a time. Even with taxes, you will be making money.

Options sold sooner than the expiration date are worth more that the stock price itself, due to the time value. This time value might help with some of the tax consequences.

 

[RockyMtn]

I received stock options for more than 15 years. I would be careful having too much of your net worth tied up in your company options. Remember the folks at Enron?

I always exercised any options that had vested and moved them into other assets. There was always another grant that year to replace what was exercised. What was not vested or not in the money stayed in the account and was only counted towards net worth if they were in the money and would vest within the time frame I had left at the company ( I was on contract).

Some companies do not allow the purchase of derivatives (puts, calls, collars, etc) in stock that is granted as part of an option plan.

 

[Dash man]

My DW has been in this pleasant situation and we've chosen to take some off the table each year. We've paid more in taxes than we like, but that is what it is and there is no magic tax break. We reinvested the money to diversify our holdings along with paying off the mortgage and our kids college bills.
One thing we did a couple of times when the price was down but still above water, was to exercise the options and hold on to the stock, except for enough to cover taxes. We then held on to the shares which have since appreciated nicely, but now will be taxed at the capital gains rate.


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[Danmar]

Start selling the options a little at a time. Even with taxes, you will be making money. Options sold sooner than the expiration date are worth more that the stock price itself, due to the time value. This time value might help with some of the tax consequences.

I think these are employee options and thus not sellable to a third party. Only can exercise and sell the shares.
I also had a large number of employee options which were all cashed out after I retired for after tax proceeds in the 8 figure range. At one point they probably would have represented about half of my investable assets. You might want to cash a few out but if you think your employer has good prospects you should keep some ( most?) for a bigger payout. That's what I did and it really paid off.
Really depends on your risk tolerance.

 

[MichaelB]

It is high, but not sky-high for a stable megacorp, and taxes are a factor.

+1

You need to read the agreement carefully to see if you are subject to any restrictions or conditions regarding hedging and selling.

Options are a nice leveraged investment, changes in the quoted price result in much bigger % changes in the value of the options, so selling may deprive you of considerable increases in future value. Of course, the opposite is also true.

 

[MRG]

I cashed mine out every few years when the price was up. I had a special problem in that Megacorp had handed out many shares in an ESOP account. Cost was zero to me cost basis a couple bucks, but at one time the equities were close to 60% of net worth. When I was able to roll that into an IRA I did. Slowly sold off the Megacorp shares.

Had I really wanted to roll the dice I could have not done the IRA, had a great NUA. In the back of my mind I kept thinking Enron. In hindsight the NUA would have been better by a large 6 figure number, but it could have gone the other way.

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[Closet_Gamer]

A bunch of years ago I was in the happy situation of having lots of deep, in-the-money options. I did all the tax hand wringing, built models, didn't sell…and then left over $400K on the table when the market moved down at the same time I was leaving the company so I had to sell. Options are leveraged assets…exciting on the way up and exciting on the way down…

So…building on that experience…I've developed a few rules which I'm using now that I'm once again deep in the money on options:

1) Even vested, in-the-money options don't go on my balance sheet. They don't "count" until they are sold. I know this is artificial, but it reduces a mental barrier to selling them.

2) I try not to sell an option until the stock price is 2x the strike price…that way I've wrung a lot of the leverage out of the option.

3) Each year at the vesting date, I calculate the % of my gain I can take off the table and the % of my upside that comes off the table by selling. If you have 10K total options outstanding, a $1 move in the stock price is worth $10k. If 1000 of those options are $10 in the money, you can take $10K off the table while only sacrificing 10% of the upside. I have found that I can get 80-85% of my gains off the table while only sacrificing 10-15% of the upside which also helps overcome the fear of missing out on higher moves.

4) I remind myself that I get "reloaded" with options annually…so my total exposure to the upside movement will stay about even as new options replace the ones I've sold. I also remind myself that the other variable is needing to leave the company when the stock price is low…most people don't get to keep the options after leaving the company.

5) You only pay taxes when something good happens. I grit my teeth and take the punch. Not having moved these assets onto the balance sheet helps how this feels as the only thing the balance sheet ever sees is the post-tax gain.

My $0.02. Lots of other strategies out there. Remember, this is a high class problem.

 

[Cobra9777]

I was also fortunate enough to deal with this problem for 15+ years. I'm retired now, but still holding some vested options, the last of which will be exercised and sold next year. I was always concerned about being too concentrated in Megacorp stock. My basic objective was to get the money into the balanced portfolio as quickly as possible after vesting, but without sacrificing potential gains or creating additional problems (mainly tax).

After having peaked around 30%, I worked it down to 15% of investable assets and then exercised and sold whatever amount I got each year as new grants. But I also tried to be opportunistic with price. I'd exercise more if the stock was at a peak, and less if it appeared to be poised for a recovery. I also tried to time exercises to keep it from pushing me into a new bracket or some other undesirable tax consequences. It's definitely no simple task to balance all this.

Most of my exercises happened around year 5 or 6 (10 yr options). I had some expire after having been in-the-money earlier. So again, my goal was to keep the exposure reasonable (~15%), get it out as soon as practical, and put it to work in the balanced portfolio. This seemed to work out OK for me.

 

[fh2000]

We have some that are due next March. I set up some customized collars in a different brokerage account so I feel no violation of the rule not to short your own company stock.

The collar trade will cost me some 'premium'. If stock continues to go up, I will keep paying premium but retain most of the overall profit. If stock tanks, I will at least recoup most of the the profit thru the short leg of the trade.

I will exercise those after 1/1/2015. So just few more days now.

 

[Toocold]

Good suggestions, all!

I also have a ESOP but cash that out as soon as I purchase stocks at a discount. I'll look into deep out of the money puts and see if there are any rules against it.

Managing deferring comp %, exercising stock options, new vestment of stock equity, and annual bonues sometimes feel like playing whack-a-mole.

 

[pb4uski]

The way I figure it the cost of lack of diversification could far exceed the tax cost of being well diversified.

 

[FIREd]

I do not consider non-qualified stock options part of our investment portfolio anymore. I see them as an unrealized source of income that can be tapped when the price is right. It's only when we exercise the options that this money shows up on our balance sheet.

 

[scrabbler1]

I cashed mine out every few years when the price was up. I had a special problem in that Megacorp had handed out many shares in an ESOP account. Cost was zero to me cost basis a couple bucks, but at one time the equities were close to 60% of net worth. When I was able to roll that into an IRA I did. Slowly sold off the Megacorp shares.

Had I really wanted to roll the dice I could have not done the IRA, had a great NUA. In the back of my mind I kept thinking Enron. In hindsight the NUA would have been better by a large 6 figure number, but it could have gone the other way.

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I used NUA to cash out my company stock when I ERed back in 2008. Nearly all of the stock's value was NUA so the tax bite, while still considerable, was not too bad (about 20% state and federal combined). At the time, I had about 1/3 of my investments in taxable accounts, 1/3 in the company stock, and 1/3 in the rest of the 401k.

 

[audreyh1]

I've been fortunate to work at a stable megacorp where the stock price has had a nice run up, and I'm sitting on a decent chunk of change of in-the-money fully vested stock options.

My worry is that they now represent almost 20% of investable assets, and it will go up to 25% once the next traunch becomes vested early next year. This is uncomfortably high for me.

Add to this is that if I exercise my options, it will be taxed at the highest marginal tax rates, and I feel I already pay enough taxes to Uncle Sam.

Has anybody else been in this situation? Any advice on how to manage this?

IMO - 20% is no big deal. If you don't want it to go higher, then you might need to trim some.

I didn't pay high marginal tax rates because I exercised and held my qualified stock options for at least a year before selling. It worked out for me. I know a lot of other folks got screwed using this approach, but then again I didn't work for a dot.com company.

A lot of people advise to limit investments in a single stock to 5% of investable assets. But if I had done that, I wouldn't have been able to retire early. The basis for my company stock was so low, that what I originally invested was small compared to my other investments, and I felt I could let it ride and hope to get lucky. My gamble worked out well.

 

[audreyh1]

I do not consider non-qualified stock options part of our investment portfolio anymore. I see them as an unrealized source of income that can be tapped when the price is right. It's only when we exercise the options that this money shows up on our balance sheet.

That is a sensible way to view it. It is not part of your net worth until you actually exercise the option. IMO normal "diversification" rules do not apply if you don't actually own the stock.

 

[Idnar7]

Just a follow up to a previous post. I exercised options after I retired each year when they were about to expire. SS came back at me saying I earned over the maximum for those years after age 62 (we claimed early) and were reducing my SS benefit. I fought back saying it was deferred income. They ultimately agreed. The stock options (W2 income) allowed me to fund IRA's for my DW and I for the first three years of retirement.

 

[fh2000]

I exercised options after I retired each year when they were about to expire.

My experience is different.

I was laid off from one company and given 3 months of severance. When that ended, I could begin applying for unemployment, and I had 30 days to exercise all my outstanding options.

 

[ERD50]

...
You need to read the agreement carefully to see if you are subject to any restrictions or conditions regarding hedging and selling. ...

MichaelB makes a good point here that I overlooked. Gotta play by the rules!

-ERD50

 

[Hamlet]

Just suck it up and pay the taxes. I've seen a lot of people lose life changing money because they put too many eggs in one basket. No company is immune from the possibility of bankruptcy, however small. Imagine waking up unemployed with 20% of your assets gone.

If you could accept that, you don't need to sell.

Otherwise, sell down to your comfort level and don't give the taxes a second thought.

 

[explanade]

I exercised the bulk of them a month before they expired. Paid a lot of taxes but hell, if I could have held them a few more years, they would have been worth more.

But the timing worked out great for me, it was in the summer of 2008 and I immediately put most of them in high yielding CDs, some as much as 5% over 2 years.

When the financial crisis hit, I didn't have too much equities exposure but I was concerned about having a lot of cash beyond the FDIC limits. Helped that they raised it from $100k to $250k so I split the sums across several accounts.

Then I started moving them to VG as the CDs matured and interest rates plunged.

Timing was propitious.

Paying taxes wasn't fun, some high 5-figure tax bills. But the way I looked at it, it was an unexpected windfall (when I got the option grants, I didn't have high expectations of them).

Maybe I could have hired a tax advisor and optimized the tax efficiency but maybe the advisor would have had me sell earlier at lower prices.

It worked out well in the end.

 

[ulrichw]

We have some that are due next March. I set up some customized collars in a different brokerage account so I feel no violation of the rule not to short your own company stock.[...]

I'd be really careful about this - the restriction against shorting your stock usually has nothing to do with which account you do it in. At least for the times I've been under similar restrictions, the account wouldn't have made a difference. This is similar to the rules that would apply to insider trading - you can't get your spouse to do the hedge for you either.

As far as the OP is concerned, I didn't see in the description whether these are non-quals or Incentive Stock Options (ISOs).

If they're ISOs, you should consider the qualifying disposition rules:
Qualifying Disposition Definition | Investopedia

This will let you treat the gain as capital gains instead of regular income, albeit while incurring the risk of holding the stock for a year after exercise. (Note also that there's a potential AMT impact in the year you exercise - it's a good idea to sell enough shares immediately to cover the AMT bill). I'd recommend doing some reading on the details of this before pulling the trigger.

Since ISOs aren't that common these days, you may have non-quals which makes things simpler, since it removes the qualifying disposition option.