If you own stock options and are not sure how to best leverage them to see favorable returns on your investment, you do not need to leave that decision up to chance. There are a few aspects to keep in mind as you think about if you should exercise stock options. Here is what you need to know to keep yourself informed, and remember-an investment professional can help you make a plan to take full advantage of your stock options.
What Does “Stock Option” Mean?
A stock option is a type of investment based on a contract. When you purchase or are granted options from your employer, you are agreeing to a few terms, like how long the contract is in effect and the details of your option. A call option contract will stipulate terms such as the price at which you may buy an asset and for how long that price applies. This means that even if the market soars above that value, the contract is binding, and you may still purchase the asset at the agreed-upon value (in this scenario, for less than it is worth).
Some types of stock options are ones that you can seek out on your own, like the previously mentioned call or put options. However, options such as ISO/NSO products are usually granted to employees of a business as part of the business’ finances. Being granted an option does not mean that you need to exercise it immediately; as with any other stock option, you may hold it for as long as you desire.
However, knowing when to “exercise” your stock option-or when to buy and sell according to the agreed terms-can be a nuanced decision. Here’s what to keep in mind.
Consider The Current Tax Rate
One of the most critical elements to remember when you exercise your options is that depending on your strategy, you may create a tax burden. In particular, pay attention to capital gains tax, alternative minimum tax (AMT) and ordinary income tax.
The difference between your stock price, and the price at which you sold, may be taxed as ordinary income. You may pay capital gains tax on the price that the stock increased between when you sold and when you exercised. However, ordinary income tax can be higher than capital gains tax, so working with an investment advisor to minimize tax risk is wise and can help you strategize when to exercise.
Holding on to any stock for at least two years will see your investment taxed at capital gains, not ordinary income. That saves you money. Consider how timing your exercise according to market value could mitigate your tax burden. If you are unsure how the taxes will change based on how you exercise your option, be sure to speak with a professional who can help you navigate the process and potential outcomes.
The Best Time?
Deciding when to exercise your stock options can be complicated, and will vary depending on your situation. If you are considering exercising before the IPO registration date, it is recommended that you not risk more than 10% of your total net worth. That’s because utilizing stock options always carries a fair amount of risk. However, exercising based on the company’s public position could save you a significant amount in taxes if the company’s public trading succeeds. You do not need to make these decisions on your own, so do not hesitate to speak with an expert. The right timing will be unique to you, and there is no universal best time to exercise your stock options.
The best way to determine if you should exercise a stock option now or later is to review your own financial wellness. Do not risk your financial security to exercise an option. An advisor can provide you guidance and clarity when making these important decisions.
Trust The Pros To Help You Make The Right Financial Decisions
If you hold stock options and are not sure what to do with them, make sure to ask the experts. The professionals at Inflection Advisors would be happy to walk you through your financial present and future. Reach out to learn more or to schedule an appointment to discuss your investing strategy. We are always available to provide customized guidance that is personalized to you.
