On Incentive Stock Options

Recently The Simple Dollar and The Digerati Life both wrote about employee stock options and when should options be cashed out. Here are my experiences and knowledge on the subject after receiving stock options as part of my compensation package at a couple companies.

• Options are a contract between you and your company. There is no cash value to your options.
• Options usually expire within a few months of your leaving a company so the best time to think about exercising it is probably when you leave.
• You can’t sell the shares you buy through options if the company is still private. There are clauses in the options agreement that the stocks would be a non liquid investment and you can’t transfer the shares.
• If you exercise incentive stock options, the difference between the current price and the exercise price add to your AMT income which could trigger an AMT tax.
• If you exercise the options and then sell the stocks within a year, the short term capital gain taxes is the same as your ordinary income, which could be 40% or more. If you wait until it becomes a long term capital gain it might be a much bigger chunk of change that you keep. So this might be an argument for exercising the options early.
• Don’t expect to become fabulously rich from options unless you are granted a significant share of the company. Think of it more like a bonus if you’re able to make money. I have had ex-coworkers who really thought that they would become millionaires from 0.000001% of a company worth less than 3 million. Basically, don’t let it go to your head and spend your money like you’ve already gotten the after tax gain of your options exercise. I’ve always told my parents, I’d be lucky if I get a couple cars out of exercising my options.

As for me, I did exercise some options a little over a year ago when I left my last company. It was only a $600 investment and now it’s a pretty stock certificate in a drawer somewhere. The company isn’t doing badly so my stocks have quadrupled in price on paper. In my current company I asked for more pay during salary negotiations, and they gave me 50% more options than the original options number instead. It turned out to be a good move. In the Valley it’s conceivable to work for a collection of small companies that give a fairly good amount of options and build up a stock portfolio of your employers, and maybe one of them will make it big.

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