Many companies offer their employees stock options as part of their compensation packages. Stock options offer the right to purchase shares of the company at a fixed exercise price for a specified number of years. For example, your employer may offer you options to purchase 10,000 shares of the company at a strike price of $1 that vests over four years with the first 25% vesting on your one-year anniversary. Generally, options are exercisable on or after their vesting date. However, some optionees have the opportunity to exercise options before they vest in what is called an early exercise option. This type of compensation may provide the opportunity for a significant payout in the future if the value of the stock continues to rise after the options are exercised. But option exercises also create the potential for a significant tax bill. Some people can reduce their tax liability by exercising stock options early, and we’ll discuss the benefits and risks of this strategy below.
In recent years, generating income from stock options has regained its popularity in executive compensation packages, after falling out of favor during the dot-com bust. Their recent resurgence means there are also growing numbers of executives making poor choices, often because they lack good advice or because they have unwarranted optimism about their companies’ stock prices. Making good decisions and maximizing the value of your stock options starts with understanding what you have. Then, you can begin to develop a strategy that optimizes their value by incorporating tax consequences, your personal risk appetite, the company’s outlook, and more.