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Author: AliFool Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2049  
Subject: Exercising, Selling, Holding Date: 2/6/2008 2:04 AM
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Say my strike price was $10/share. My first batch vested one year in (12 months at once) and I exercised and sold immediately in a cashless transaction. I paid income tax (plus other taxes and transaction fees) on the difference between my strike price and the market value on the day I sold.

My next options started to vest monthly. I think where I screwed up is that I did not exercise them (and sell to cover) each month as they vested. But I've been sitting here thinking, I've got options vesting every month, and when I sell them, a year and a day after each batch vests, I will only pay 15% long term capital gains. I was wrong, wasn't I? (And this in spite of owning and reading Consider Your Options.)

Say the stock is now at $35/share. It's been more than a year since my month-13 options vested. If I exercise and sell now, I owe ***regular income tax (plus other taxes and transaction fees)*** on the difference between my strike price and the current market value of the stock... the $25/share it appreciated in the meantime. In other words, if I exercise and sell now, I don't pay 15% tax, I pay income tax and then some, don't I? OUCH!

But I have other choices. If I were to exercise, sell to cover, and hold starting NOW, I'd pay income and other taxes on the $25 per share appreciation, and capital gains tax on any additional appreciation -- short-term if I sell before a year and a day from NOW, long term if more than a year and a day from now. Of course, the stock price could also go down, in which case I'd still owe the taxes on the $25/share it appreciated between vesting and exercising, but I could also incur a loss ($3K per year of which might be deductible).

I guess I'm kicking myself because I thought I'd be taxed 15%, but it turns out that it will be more like 35% or 40% when all is said and done. But if I don't want to incur risk by holding EVEN LONGER, that's the choice I make, right? I think what I meant to do was exercise and sell-to-cover, then sell the rest after a year and a day. I'm kicking myself because I never did that, and in the meantime the stock did go up.

Thank you for any help or insight you can offer.

--AF
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Author: progmtl Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2047 of 2049
Subject: Re: Exercising, Selling, Holding Date: 2/6/2008 10:03 AM
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I believe your analysis of the tax and income consequences is correct for non-qualified stock options (NQSO).

Still, despite the higher tax burden, many people choose to perform "same-day sales" as you have done to eliminate the risk inherent in holding large chunks of stock in their employer.

Also, if you like the long-term prospects of your company and aren't planning on leaving soon, don't be too quick to exercise those options once they vest. Options are often valid for a long time (10 years is typical) and you could end up with a lot more money down the road. Of course, there is opportunity cost risk in that approach, but I find that more appealing than the very real risk of stock depreciation if you exercise and hold.

hope this helps,
-progmtl.

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Author: mathetes Big red star, 1000 posts Old School Fool Motley Fool One Everlasting Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2048 of 2049
Subject: Re: Exercising, Selling, Holding Date: 2/6/2008 11:21 AM
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Also, if you like the long-term prospects of your company and aren't planning on leaving soon, don't be too quick to exercise those options once they vest. Options are often valid for a long time (10 years is typical) and you could end up with a lot more money down the road. Of course, there is opportunity cost risk in that approach, but I find that more appealing than the very real risk of stock depreciation if you exercise and hold.

Indeed!

I know many people retired from the company for which I worked (I also have now retired), people who retired from jobs as factory workers or clerical/secretarial positions, retired as millionaires because they just held their options until close to the end of the 10 years they had to exercise, and then did a buy-hold.

As the first post said, one does have to face the risk of the stock's falling in value --- either by waiting out the period before exercising, OR by buying and holding for the long term --- but that's no different from any other long term buy-hold strategy for building wealth with stocks. Stock options from one's own company are great because (if you think it's a good company with good long-term prospects) those options are better than the best long term calls (LEAPs) you can buy on the open market; and they're free!

mathetes

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Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2049 of 2049
Subject: Re: Exercising, Selling, Holding Date: 2/6/2008 12:01 PM
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Still, despite the higher tax burden, many people choose to perform "same-day sales" as you have done to eliminate the risk inherent in holding large chunks of stock in their employer.

There is one way to limit this risk, and to enjoy the benefit of preferred capital gains income tax rates, if you own other long-term shares. It is a simple technique of exercising and holding as they vest, but selling an equal amount of other long-term shares (or perhaps more than an equal amount to also cover the taxes due). Obviously, and as stated earlier, depending on how the stock appreciates or depreciates, you may or may not save on your overall tax bill. And, of course, the tax due on the difference between the strike price and the market value at exercise will always be taxed as ordinary income for NQSOs.

I also think that some companies will permit you to "turn in" other shares you own to cover the exercise cost (though probably not the taxes). It's all in "Consider Your Options" with lots of good examples.

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