Deciding to Accept Options

What are the pros and cons of ESOs?

Accepting free money from your employer seems like a pretty easy decision. However, like most things in life, it's never that simple. Employee stock options (ESOs) should be carefully considered within the context of your entire investment portfolio. For instance, if you already own mutual funds that have significant holdings in your company stock, owning more of the same makes little sense.

So, what can you do?

First, you aren't required to exercise options granted, so don't feel you must buy the stock. However, options usually come with a vesting period and maximum shelf life, so it's possible you won't have a decision to make for a year or more anyway. When the time comes, you'll have three choices:

  • Exercise the options paying with cash.
  • Pay for the stock options with company stock you already own.
  • Borrow cash from your broker to pay for the options and at the same time sell the required number of shares to pay back the loan.

In all three cases you can immediately sell some or all of the options, thus profiting from the difference between the grant price and exercise price. That said, you don't have to exercise your shares immediately upon vesting. In most cases you'll have up to ten years to do so, although it's rare these days for an employee to stay with a company for that length of time.

Depending on the expiry date of the options, experts suggest holding as long as possible to maximize appreciation of the stock. In some cases, this doesn't make sense. For instance, your company may be struggling or even in decline and you want to exercise and sell the options before they are worth any less to you. Another scenario for selling would be to avoid getting pushed into a higher tax bracket because of the profits generated by exercising options. Lastly, you already own a bunch of stock and want to diversify your portfolio.

While it's sensible to take your time when considering the choices available with ESOs, it's not advisable to turn them down outright. Usually, there is a cash value attached to them that you won't obtain elsewhere in your salary compensation.

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