Exercise stock options or not
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All stock options come with an expiration date, that is, the last date by which the option holder must exercise her option or lose it. Many people believe that it is wise to wait until just before the expiration date to exercise their stock options and purchase the option shares.
And they may be right, under most circumstances. There are times, however, when exercising your options early is a good idea. Here are four reasons to consider exercising your options before the expiration date:. You currently own, or hold options on, too many shares of company stock than is healthy for your overall investment portfolio. You believe the stock is a good investment for the long term and you want to buy as many shares as you can afford. Your financial gain from exercising your options all at once would push you into a higher tax bracket, so you are spreading out your stock purchases under the option agreement.
Remember that there are tax implications to exercising your stock options.
Exercising stock options: Everything you should know | Carta
More on tax considerations below. You purchase your option shares with cash and hold onto them. This gives you the maximum investment in company stock, providing you with the potential for gains from increases in stock value and payment of dividends if any. You may need to deposit cash into your brokerage account or borrow on margin to pay for your shares. You will also likely pay brokerage commissions, fees, and taxes.
You purchase your option shares and then and immediately sell them. In many cases, your brokerage will allow this transaction without using your own cash, with the proceeds from the stock sale covering the purchase price, as well as the commissions, fees, and taxes associated with the transaction.
Topic No. 427 Stock Options
This choice provides you with cash in your pocket to put into other investments or use as you otherwise see fit. You exercise the option and then immediately sell just enough shares to cover the purchase price, commissions, fees, and taxes. You would be better off buying on the market.
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But if the price is on the rise, you may want to wait on exercising your options. Once you exercise them, your money is sunk in those shares. So why not wait until the market price is where you would sell? That said, if all indicators point to a climbing stock price and you can afford to hold your shares for at least a year, you may want to exercise your options now. Also, if your time period to exercise is about to expire, you may want to exercise your options to lock in your discounted price. You will usually need to pay taxes when you exercise or sell stock options.
What you pay will depend on what kind of options you have and how long you wait between exercising and selling. With NQSOs, the federal government taxes them as regular income. The company granting you the stock will report your income on your W The amount of income reported will depend on the bargain element also called the compensation element. When you decide to sell your shares, you will have to pay taxes based on how long you held them. If you exercise options and then sell the shares within one year of the exercise date, you will report the transaction as a short-term capital gain.
This type of capital gain is subject to the regular federal income tax rates. If you sell your shares after one year of exercise, the sale falls under the category of long-term capital gains. The taxes on long-term capital gains are lower than the regular rates, which means you could save money on taxes by holding your shares for at least one year.
ISOs operate a bit differently. You do not pay taxes when you exercise ISOs, though the amount of the bargain element may trigger the alternative minimum tax AMT , which phases out income exemptions targeted for low- and middle-income taxpayers. When you sell shares from ISO options, you will need to pay taxes on that sale. If you sell the shares as soon as you exercise them, the bargain element is treated as regular income. Stock options are becoming a more common way for companies to attract and keep employees. It has greater time value remaining.
A contract that is out-of-the-money say an Oct call , consists only of time value. It rarely makes sense to exercise an option that has time value remaining because that time value is lost. Furthermore, it rarely makes sense to exercise an out-of-the-money contract. It is not necessary to own the shares to profit from a price increase, and you lose nothing by continuing to hold the call option. Let's assume one week has passed and the company makes an unexpected announcement.
That's unfortunate. When you sell an option, you typically pay a commission.
When you exercise an option, you usually pay a fee to exercise and a second commission to sell the shares. This combination is likely to cost more than simply selling the option, and there is no need to give the broker more money when you gain nothing from the transaction. However, the costs will vary, and some brokers now offer commission-free trading—so it pays to do the math based on your broker's fee structure.
When you convert a call option into stock by exercising, you now own the shares. You must use cash that will no longer be earning interest to fund the transaction, or borrow cash from your broker and pay interest on the margin loan. In both cases, you are losing money with no offsetting gain. Instead, just hold or sell the option and avoid additional expenses. Options are subject to automatic exercise at expiration, which means that any contract that is in the money at expiration will be exercised, per rules of the Options Clearing Corporation.
Occasionally a stock pays a big dividend and exercising a call option to capture the dividend may be worthwhile. Or, if you own an option that is deep in the money , you may not be able to sell it at fair value.
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If bids are too low, however, it may be preferable to exercise the option to buy or sell the stock. Do the math. There are solid reasons for not exercising an option before and into the expiration date.
When to Exercise Stock Options in a Private Company or Startup
In fact, unless you want to own a position in the underlying stock, it is often wrong to exercise an option rather than selling it. If the contract is in the money heading into the expiration and you do not want it exercised, then be sure to close it through an offsetting sale or the contract will be automatically exercised per the rules of the Options Clearing Corporation.
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