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When to Exercise Stock Options
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When to Exercise Stock Options
Employee stock options can be lucrative, but knowing when to exercise your options isn't always straightforward.
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Chris Davis is a Managing Editor on the Investing team. He has passed the Series 65 (Uniform Investment Adviser Law Exam) and covered the stock market, investing strategies, investment accounts and cryptocurrency. His work has appeared in The Associated Press, The Washington Post, MSN, Yahoo Finance, MarketWatch, Newsday and TheStreet. Published in Managing Editor + more + moreIt’s always great to have options. But when it comes to your employee stock options, weighing so many variables can make it challenging to pinpoint the most opportune time to exercise and reap your financial reward.
It’s always great to have options. But when it comes to your employee stock options, weighing so many variables can make it challenging to pinpoint the most opportune time to exercise and reap your financial reward.Before considering when to exercise your options, let’s review the basics.
Before considering when to exercise your options, let’s review the basics. AdvertisementGet matched to a financial advisor for free with NerdWallet Advisors Match.
What are stock options?
What are stock options?Employee stock options are a type of equity compensation that gives you the right (but not the obligation) to buy a certain number of company shares at a specified price. Vesting refers to the point in time after which you are allowed to exercise your options (purchase company shares).
Employee stock options are a type of equity compensation that gives you the right (but not the obligation) to buy a certain number of company shares at a specified price. Vesting refers to the point in time after which you are allowed to exercise your options (purchase company shares).Stock options help to align your interests with that of your employer. The higher your company’s share price goes, the more your options may be worth, providing extra incentive to help drive your company’s success.
Stock options help to align your interests with that of your employer. The higher your company’s share price goes, the more your options may be worth, providing extra incentive to help drive your company’s success.There are two types of stock options: exchange-traded options and employee stock options. Here, we’re focusing on the latter.
There are two types of stock options: exchange-traded options and employee stock options . Here, we’re focusing on the latter.» MORE: How to find free or cheap financial advice
» MORE: » MORE: How to find free or cheap financial adviceHow employee stock options work
How employee stock options workIt all starts on the grant date, which is the day you receive options from your employer. The grant paperwork will tell you:
It all starts on the grant date, which is the day you receive options from your employer. The grant paperwork will tell you:How many company shares you’re eligible to purchase.
How many company shares you’re eligible to purchase.What price you’ll pay per share (this is the strike price, also known as the exercise price).
What price you’ll pay per share (this is the strike price, also known as the exercise price).How long until the options vest (that is, how long you must wait until you have the right to exercise your options).
How long until the options vest (that is, how long you must wait until you have the right to exercise your options).When the options expire (how long you have to exercise your options).
When the options expire (how long you have to exercise your options).Your stock options give you the right to exercise if and when you want to, but you’re never obligated to do so.
Your stock options give you the right to exercise if and when you want to, but you’re never obligated to do so.If you choose to exercise your stock options, you can hold on to your company shares or sell them.
If you choose to exercise your stock options, you can hold on to your company shares or sell them.» MORE: Is it better to get stock options or restricted stock units?
» MORE: » MORE: Is it better to get stock options or restricted stock units?Types of employee stock options
Types of employee stock optionsThere are two primary types of employee stock options, which differ in a few ways.
There are two primary types of employee stock options, which differ in a few ways.Incentive stock options, or ISOs. Also known as statutory or qualified stock options, incentive stock options can receive preferential tax treatment. Holding the exercised shares for a certain amount of time can tick the “qualifying disposition” box, meaning you are taxed when you sell the shares, and only at capital gains tax rates. Companies only give ISOs to employees.
Incentive stock options, or ISOs. Incentive stock options, or ISOs. Also known as statutory or qualified stock options, incentive stock options can receive preferential tax treatment. Holding the exercised shares for a certain amount of time can tick the “qualifying disposition” box, meaning you are taxed when you sell the shares, and only at capital gains tax rates . Companies only give ISOs to employees.Nonstatutory options, or NSOs. These are also called nonqualified stock options. You are taxed at ordinary income tax rates when you exercise, and you are taxed again (at capital gains tax rates) if you sell the shares at a profit. Companies can grant NSOs to outside service providers, consultants or advisors.
Nonstatutory options, or NSOs. Nonstatutory options, or NSOs. These are also called nonqualified stock options . You are taxed at ordinary income tax rates when you exercise, and you are taxed again (at capital gains tax rates) if you sell the shares at a profit. Companies can grant NSOs to outside service providers, consultants or advisors.» Looking to save on taxes? Learn about strategies to reduce capital gains taxes
» Looking to save on taxes? » Looking to save on taxes? Learn about strategies to reduce capital gains taxesKnowing which type of options you have and understanding how stock options are taxed is crucial, as this information may help you decide when to exercise your stock options.
Knowing which type of options you have and understanding how stock options are taxed is crucial, as this information may help you decide when to exercise your stock options.When to exercise stock options
When to exercise stock optionsAssuming you stay employed at the company, you can usually exercise your options any time between when they vest and when they expire — typically, this spans up to 10 years.
Assuming you stay employed at the company, you can usually exercise your options any time between when they vest and when they expire — typically, this spans up to 10 years.If you’re leaving your employer, check your grant paperwork to see how long you have to exercise; this is usually referred to as the “post-termination exercise period.”
If you’re leaving your employer, check your grant paperwork to see how long you have to exercise; this is usually referred to as the “post-termination exercise period.”There are four things to consider when determining the ideal time to exercise your stock options, but it's a good idea to consult with a financial advisor who understands equity compensation and can help you evaluate all the factors of your particular situation.
There are four things to consider when determining the ideal time to exercise your stock options, but it's a good idea to consult with a financial advisor who understands equity compensation and can help you evaluate all the factors of your particular situation.1. Whether your options have value
1. Whether your options have valueIt only makes sense to exercise your options if they have value. If the strike price (or exercise price) of your stock options is lower than the market price of your company shares trading on the exchange, they have value.
It only makes sense to exercise your options if they have value. If the strike price (or exercise price) of your stock options is lower than the market price of your company shares trading on the exchange, they have value.In this case, exercising your options means you can purchase company shares for a below-market price. Then you could turn around and sell those shares on the stock market and pocket the difference — known as the “bargain element.” This could create a tax bill on the profit, however.
In this case, exercising your options means you can purchase company shares for a below-market price. Then you could turn around and sell those shares on the stock market and pocket the difference — known as the “bargain element.” This could create a tax bill on the profit, however.Alternatively, if you believe in your company’s future prospects, you may want to hold on to your options. If your company’s share price rises, your options’ worth will continue to grow while putting off any tax consequences. The longer time frame could give your options even more value.
Alternatively, if you believe in your company’s future prospects, you may want to hold on to your options. If your company’s share price rises, your options’ worth will continue to grow while putting off any tax consequences. The longer time frame could give your options even more value. 🤓 Nerdy TipDon’t forget to keep track of the expiration date. Unfortunately, options with value can end up wasted if not exercised in time.
Don’t forget to keep track of the expiration date. Unfortunately, options with value can end up wasted if not exercised in time.2. Whether your company is public or private
2. Whether your company is public or privateIt makes a difference if your company is publicly traded or privately owned. The considerations in a private company can be trickier.
It makes a difference if your company is publicly traded or privately owned. The considerations in a private company can be trickier.Shares aren’t traded on a stock exchange, so you’ll need to pay out of pocket to exercise and fund the purchase (instead of selling some of the shares to cover your cost).
Shares aren’t traded on a stock exchange, so you’ll need to pay out of pocket to exercise and fund the purchase (instead of selling some of the shares to cover your cost).You’ll take on the risk of holding illiquid shares that could be hard to sell. It could take a long time before an initial public offering (IPO) or other liquidity event occurs for you to cash out.
You’ll take on the risk of holding illiquid shares that could be hard to sell. It could take a long time before an initial public offering (IPO) or other liquidity event occurs for you to cash out.If your company is private and files for an IPO, it could be a good time to consider exercising your incentive stock options. Here’s why:
If your company is private and files for an IPO, it could be a good time to consider exercising your incentive stock options. Here’s why:ISOs are subject to a holding period of one year post-exercise — and two years post-grant — in order to qualify for favorable tax treatment.
ISOs are subject to a holding period of one year post-exercise — and two years post-grant — in order to qualify for favorable tax treatment.Once a company files for an IPO, it generally takes several months to prepare before the actual listing.
Once a company files for an IPO, it generally takes several months to prepare before the actual listing.Immediately upon listing, employees of the company going public are typically subject to a lock-up period where they are restricted from selling shares for up to six months after listing.
Immediately upon listing, employees of the company going public are typically subject to a lock-up period where they are restricted from selling shares for up to six months after listing.By exercising options at the time of filing, the holding time from the filing to the post-lock-up period may coincide with the time requirements for preferential tax treatment.
By exercising options at the time of filing, the holding time from the filing to the post-lock-up period may coincide with the time requirements for preferential tax treatment.3. Whether it fits with your financial situation
3. Whether it fits with your financial situationWith many financial decisions, the best time to do something is when it works for you and your unique goals.
With many financial decisions, the best time to do something is when it works for you and your unique goals.Your circumstances may allow you to wait to exercise, which could possibly give the market price of your company shares more time to rise. For example:
Your circumstances may allow you to wait to exercise, which could possibly give the market price of your company shares more time to rise. For example:You may not need or want additional income from exercising your options and selling shares now.
You may not need or want additional income from exercising your options and selling shares now.If you have deferred compensation coming in for a few years, you may want to put off exercising your options until later.
If you have deferred compensation coming in for a few years, you may want to put off exercising your options until later.However, you may need cash for some other purpose — to start a business, to fund education or to purchase a home, for example. Depending on the other aspects of your financial situation, exercising your options and selling shares may help you fund another more compelling goal or investment opportunity.
However, you may need cash for some other purpose — to start a business, to fund education or to purchase a home, for example. Depending on the other aspects of your financial situation, exercising your options and selling shares may help you fund another more compelling goal or investment opportunity.Another thing to consider is your overall financial portfolio and its asset allocation. If you are overly exposed to your company shares, you may want to exercise your options and sell your company shares, using those proceeds to diversify your portfolio.
Another thing to consider is your overall financial portfolio and its asset allocation . If you are overly exposed to your company shares, you may want to exercise your options and sell your company shares, using those proceeds to diversify your portfolio .4. Whether it makes sense for your taxes
4. Whether it makes sense for your taxesDepending on the type of employee stock options you own, you may face varied tax treatments such as ordinary income tax, capital gains tax and alternative minimum tax (AMT). Consider the tax implications of exercising your options and holding on to company shares prior to selling.
Depending on the type of employee stock options you own, you may face varied tax treatments such as ordinary income tax, capital gains tax and alternative minimum tax (AMT). Consider the tax implications of exercising your options and holding on to company shares prior to selling.For ISOs with a qualifying disposition, there’s typically no tax upon exercise — you’re taxed once you sell your company shares.
For ISOs with a qualifying disposition, there’s typically no tax upon exercise — you’re taxed once you sell your company shares.For NSOs or ISOs without a qualifying disposition, the bargain element is usually taxed at ordinary income tax rates in the year of exercise.
For NSOs or ISOs without a qualifying disposition, the bargain element is usually taxed at ordinary income tax rates in the year of exercise.If you're already in a high income tax bracket, or the additional income from exercising your stock options could push you into a higher income tax bracket, you may want to delay exercising your options or spread the exercise of options out over a few — potentially lower tax — years.
If you're already in a high income tax bracket, or the additional income from exercising your stock options could push you into a higher income tax bracket, you may want to delay exercising your options or spread the exercise of options out over a few — potentially lower tax — years.If you’re holding shares in order to receive favorable tax treatment, the bargain element could trigger AMT.
If you’re holding shares in order to receive favorable tax treatment, the bargain element could trigger AMT.» MORE: Check out our guide to employee equity compensation
» MORE: » MORE: Check out our guide to employee equity compensation Advertisement1
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Financial Planning Retirement Planning Investment Management Tax Strategy OtherShould you exercise early?
Should you exercise early?Your company may allow you to exercise employee stock options early (before they vest). This is sometimes referred to as an 83(b) election.
Your company may allow you to exercise employee stock options early (before they vest). This is sometimes referred to as an 83(b) election .It may seem counterintuitive to pay for something before it becomes yours. And, exercising early comes with additional risk: The shares you buy may never reach the value that you want.
It may seem counterintuitive to pay for something before it becomes yours. And, exercising early comes with additional risk: The shares you buy may never reach the value that you want.So, why would anyone consider exercising early? First, it starts the holding- period clock for ISOs to qualify for favorable tax treatment. Second, early exercise could help reduce taxes.
So, why would anyone consider exercising early? First, it starts the holding- period clock for ISOs to qualify for favorable tax treatment. Second, early exercise could help reduce taxes.If you’re able to buy the shares when the strike price is close to the market price, you can file an 83(b) election to request that the IRS recognize your income at this point in time — before the shares appreciate further.
If you’re able to buy the shares when the strike price is close to the market price, you can file an 83(b) election to request that the IRS recognize your income at this point in time — before the shares appreciate further.Since you’ll have earned little to no income from the transaction, you may pay less tax than you might otherwise pay after the shares grow in value down the road.
Since you’ll have earned little to no income from the transaction, you may pay less tax than you might otherwise pay after the shares grow in value down the road.But note, you'll need to file the 83(b) election within 30 days of exercise.
But note, you'll need to file the 83(b) election within 30 days of exercise.» Still unsure when to exercise? Learn how to choose a financial advisor.
» Still unsure when to exercise? » Still unsure when to exercise? Learn how to choose a financial advisor . About the author Tiffany Lam-Balfour Tiffany Lam-Balfour Tiffany Lam-Balfour is a former investing writer and spokesperson at NerdWallet. Previously, she was a senior financial advisor and sales manager at Merrill Lynch. Her work has been featured in MSN, MarketWatch, Entrepreneur, Nasdaq and Yahoo Finance. Tiffany earned a finance and management degree from The Wharton School of the University of Pennsylvania. See full bio.ON THIS PAGE
What are stock options? What are stock options? How employee stock options work How employee stock options work When to exercise stock options When to exercise stock options Should you exercise early? Should you exercise early?ON THIS PAGE
What are stock options? What are stock options? How employee stock options work How employee stock options work When to exercise stock options When to exercise stock options Should you exercise early? Should you exercise early? More like this Investment Basics Investing How Much Does a Financial Advisor Cost? Most financial advisors charge based on how much money they manage for you. Fees are typically 1% a year but can be lower. Taryn Phaneuf Do You Need a Financial Advisor? 7 Ways to Tell You may need a financial advisor if you're facing big life changes, don't have financial goals, have complex compensation, high tax bills or for other reasons. Taryn Phaneuf How to Find Cheap or Free Financial Advice Quality financial advice is more accessible than ever — and much of it is free or inexpensive. Here's how to get it. June Sham 3 Steps to Prepare for Your First Financial Advisor Meeting Here's what think about and bring to your first meeting with a financial advisor. June Sham