October 23, 2008
Considering your Stock Options
Considering Your Options
By David N. Chazin
In conjunction with Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Mr. Chazin is a regular contributor to PlannerConnect.
To attract and keep top employees, more companies are offering them employee stock options. If you receive employee stock options as part of your compensation package, careful planning can help you make the most of them.
What Is an Employee Stock Option?
Employee stock options give you the right to buy stock in the corporation that employs you at a specified price – the exercise or “strike” price – at a future time. Usually, the strike price is equal to the stock’s market value at the time the option is granted. You benefit if the value of the stock rises and you sell it for more than you paid for it.
Employee stock options usually have an “exercise period” during which you have to buy the stock or lose the options. They also may have a “vesting schedule” that requires you to wait a certain period before you can exercise your option.
Employee stock options come in two basic varieties: nonqualified and incentive.
Nonqualified Options
With a nonqualified stock option, you generally owe no taxes on the option until you exercise it. Then, you must report income equal to the difference between the stock’s market value and your exercise price.
For example, if you exercise an option to buy 100 shares of your employer’s stock for $10 per share when the stock is trading at $25 a share, you are considered to have received $1,500 (100 shares × $15 profit per share) of taxable income that year. You’ll have to pay tax on that income at regular tax rates, which range as high as 35%.
Once you exercise your option, you own the shares of stock. You can sell your shares right away or hold on to them and sell later. Returning to the example, you’ll make $1,500 if you sell the stock for $25 a share. Sell it for $35 and you’ll make another $1,000 (taxable as a capital gain). For most investors, the maximum long-term capital gains tax rate on stock held more than a year is 15% (through 2008).
Incentive Stock Options
With incentive stock options (ISOs), you don’t generally recognize any income for regular tax purposes when the option is granted or exercised. Rather, income is recognized only when you sell the stock and, if you meet two requirements, it’s taxed at the lower capital gains rates. Those requirements: You must wait until you’ve had the stock more than one year before you sell and the date of the sale must be more than two years after the date you were granted the option.
Watch Out for AMT
However, with ISOs, you could find yourself subject to alternative minimum tax (AMT) in the year you exercise the option. AMT is intended to prevent people from reaping more than their fair share of benefits when they use certain deductions, credits, and exclusions to reduce regular income tax. The difference between the price you pay for the stock when you exercise an ISO and the stock’s market value at that time is considered an adjustment for AMT purposes. If you’re subject to AMT, you effectively have to pay tax on this “profit” even though you haven’t yet sold your stock.
A common employee stock option strategy is to hold on to options as long as the stock price continues to rise. And waiting until you have plans for the money – college expenses, a new home, or retirement – can keep you from spending any profits frivolously. Talk with your professional financial advisor. He or she can help you integrate your employee stock options into your overall investment program.
David N. Chazin is part of a network of qualified financial planners affiliated with PlannerConnect. You can reach him at David.Chazin@LFG.com, or to connect with a financial planner in your area please call (800) 318-7848, or visit the PlannerConnect website.
David N. Chazin, is a registered representative of Lincoln Financial Advisors, a broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor,3000 Executive Parkway, Suite 400, San Ramon, CA 94583, (925) 275-0300. Insurance offered through Lincoln affiliates and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.
By: David Chazin
About the Author:
By David N. Chazin
In conjunction with Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Mr. Chazin is a regular contributor to PlannerConnect.
To attract and keep top employees, more companies are offering them employee stock options. If you receive employee stock options as part of your compensation package, careful planning can help you make the most of them.
What Is an Employee Stock Option?
Employee stock options give you the right to buy stock in the corporation that employs you at a specified price – the exercise or “strike” price – at a future time. Usually, the strike price is equal to the stock’s market value at the time the option is granted. You benefit if the value of the stock rises and you sell it for more than you paid for it.
Employee stock options usually have an “exercise period” during which you have to buy the stock or lose the options. They also may have a “vesting schedule” that requires you to wait a certain period before you can exercise your option.
Employee stock options come in two basic varieties: nonqualified and incentive.
Nonqualified Options
With a nonqualified stock option, you generally owe no taxes on the option until you exercise it. Then, you must report income equal to the difference between the stock’s market value and your exercise price.
For example, if you exercise an option to buy 100 shares of your employer’s stock for $10 per share when the stock is trading at $25 a share, you are considered to have received $1,500 (100 shares × $15 profit per share) of taxable income that year. You’ll have to pay tax on that income at regular tax rates, which range as high as 35%.
Once you exercise your option, you own the shares of stock. You can sell your shares right away or hold on to them and sell later. Returning to the example, you’ll make $1,500 if you sell the stock for $25 a share. Sell it for $35 and you’ll make another $1,000 (taxable as a capital gain). For most investors, the maximum long-term capital gains tax rate on stock held more than a year is 15% (through 2008).
Incentive Stock Options
With incentive stock options (ISOs), you don’t generally recognize any income for regular tax purposes when the option is granted or exercised. Rather, income is recognized only when you sell the stock and, if you meet two requirements, it’s taxed at the lower capital gains rates. Those requirements: You must wait until you’ve had the stock more than one year before you sell and the date of the sale must be more than two years after the date you were granted the option.
Watch Out for AMT
However, with ISOs, you could find yourself subject to alternative minimum tax (AMT) in the year you exercise the option. AMT is intended to prevent people from reaping more than their fair share of benefits when they use certain deductions, credits, and exclusions to reduce regular income tax. The difference between the price you pay for the stock when you exercise an ISO and the stock’s market value at that time is considered an adjustment for AMT purposes. If you’re subject to AMT, you effectively have to pay tax on this “profit” even though you haven’t yet sold your stock.
A common employee stock option strategy is to hold on to options as long as the stock price continues to rise. And waiting until you have plans for the money – college expenses, a new home, or retirement – can keep you from spending any profits frivolously. Talk with your professional financial advisor. He or she can help you integrate your employee stock options into your overall investment program.
David N. Chazin is part of a network of qualified financial planners affiliated with PlannerConnect. You can reach him at David.Chazin@LFG.com, or to connect with a financial planner in your area please call (800) 318-7848, or visit the PlannerConnect website.
David N. Chazin, is a registered representative of Lincoln Financial Advisors, a broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor,3000 Executive Parkway, Suite 400, San Ramon, CA 94583, (925) 275-0300. Insurance offered through Lincoln affiliates and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.
By: David Chazin
About the Author:
David Chazin is a fee-based financial planner with Sagemark Consulting. His practice focuses on providing his clients with a comprehensive solution to their financial needs. He delivers objective, strategic, and prudent advice designed to help his clients accumulate, retain and transfer wealth. This typically involves developing a customized, fully comprehensive financial plan identifying issues that need to be addressed and outlining steps that need to be taken. David then helps his clients implement the recommended strategies to best reach their financial goals, giving them a great deal of personal attention and adapting their plan to fit their ever-changing lives.
Filed under Finance by Administrator
October 9, 2008
How to Trade Call Options
The majority of casual investors buy and sell stocks. If they are bearish on a stock, some will even short-sell stock. But relatively few investors fully understand and take advantage of trading options.
With stocks, you own a small piece of a company. However, with options, you purchase the right to buy or sell underlying stock. There are two basic types of options – calls and puts. When you purchase a call option, you buy the right to purchase a stock at a specific price before a specific date. When purchasing put options, you buy the right to sell a stock at a specific price before a specific date. Like stocks, you can both buy and sell options.
Traders consider buying call options when they are bullish on an underlying stock. As the stock rises, call options, in general, also rise. There are, though, some important differences between buying an underlying stock and its call options. First, options are cheaper than buying the underlying stock. If you a share of XYZ is $100, it may cost you the same to control 1000 shares with options.
Options are cheaper because they have a strike price and an expiration date. The strike price of a call option is the price at which you have the right to purchase the stock. If the price of an underlying stock is above the strike price, the call option is considered “in-the-money.” If the price of the stock is below the strike price, the call option is “out-of-the-money” while it is “at-the-money” if the stock is the same price as the strike price. Call options that are in-the-money have inherent value. For example, let’s say the price of stock XYZ increased to $105. You, however, own a call option with a strike price of $100. You thus have the option to buy XYZ at $100 while selling it for $105. This in-the-money call option thus as an inherent value of $5. Call options that are at-the-money do not have any inherent value. For instance, it would not be worth it to exercise a call option with a strike price of $15 because you cannot sell it for a profit. Call options that are out-of-the-money actually have a negative inherent value since the stock would have to rise just to get to the strike price. The farther the stock price is from the strike price, the lower the inherent value.
The expiration date is the time until which you have to exercise your option. Because options expire, they have a time value. As the expiration draws nearer, the time value of call options decrease because there is less time for the underlying stock to increase in value. A call option that expires in a year will therefore have much greater time value than a call option that expires in a week. The price of options are roughly calculated by:
Option price = inherent value + time value
There are several exit strategies with call options. If you do nothing and let an option expire, call options that are at-the-money or out-of-the-money will become worthless – they will have no inherent or time value. However, if a call option is in-the-money at expiration, you can exercise your option for a profit. Many option trading companies will automatically exercise options that are in-the-money at expiration for you.
Most option traders, however, have no intention of ever owning the underlying stock. Traders often sell their options well before expiration. Call options, in general, increase in value with the underlying stock. Thus, if a stock rises, you can usually sell a corresponding call option at a profit.
This can be beneficial because it leverages your capital. Let’s say you have $1000 to invest. If a share of XYZ costs $100, you can buy 10 shares. However, a call option of XYZ, with a strike price of $100, costs only $10. You can thus alternatively purchase 100 call options of XYZ. If shares of XYZ go to $105 at expiration, owning the stock would give you a profit of $50. Owning the options, however, would give you a profit of roughly $500. The risk in call options, however, is that this increase in price needs to occur before the expiration date.
For more information about trading options, visit DayTradingModels.com
By: Greg Chan
About the Author:
With stocks, you own a small piece of a company. However, with options, you purchase the right to buy or sell underlying stock. There are two basic types of options – calls and puts. When you purchase a call option, you buy the right to purchase a stock at a specific price before a specific date. When purchasing put options, you buy the right to sell a stock at a specific price before a specific date. Like stocks, you can both buy and sell options.
Traders consider buying call options when they are bullish on an underlying stock. As the stock rises, call options, in general, also rise. There are, though, some important differences between buying an underlying stock and its call options. First, options are cheaper than buying the underlying stock. If you a share of XYZ is $100, it may cost you the same to control 1000 shares with options.
Options are cheaper because they have a strike price and an expiration date. The strike price of a call option is the price at which you have the right to purchase the stock. If the price of an underlying stock is above the strike price, the call option is considered “in-the-money.” If the price of the stock is below the strike price, the call option is “out-of-the-money” while it is “at-the-money” if the stock is the same price as the strike price. Call options that are in-the-money have inherent value. For example, let’s say the price of stock XYZ increased to $105. You, however, own a call option with a strike price of $100. You thus have the option to buy XYZ at $100 while selling it for $105. This in-the-money call option thus as an inherent value of $5. Call options that are at-the-money do not have any inherent value. For instance, it would not be worth it to exercise a call option with a strike price of $15 because you cannot sell it for a profit. Call options that are out-of-the-money actually have a negative inherent value since the stock would have to rise just to get to the strike price. The farther the stock price is from the strike price, the lower the inherent value.
The expiration date is the time until which you have to exercise your option. Because options expire, they have a time value. As the expiration draws nearer, the time value of call options decrease because there is less time for the underlying stock to increase in value. A call option that expires in a year will therefore have much greater time value than a call option that expires in a week. The price of options are roughly calculated by:
Option price = inherent value + time value
There are several exit strategies with call options. If you do nothing and let an option expire, call options that are at-the-money or out-of-the-money will become worthless – they will have no inherent or time value. However, if a call option is in-the-money at expiration, you can exercise your option for a profit. Many option trading companies will automatically exercise options that are in-the-money at expiration for you.
Most option traders, however, have no intention of ever owning the underlying stock. Traders often sell their options well before expiration. Call options, in general, increase in value with the underlying stock. Thus, if a stock rises, you can usually sell a corresponding call option at a profit.
This can be beneficial because it leverages your capital. Let’s say you have $1000 to invest. If a share of XYZ costs $100, you can buy 10 shares. However, a call option of XYZ, with a strike price of $100, costs only $10. You can thus alternatively purchase 100 call options of XYZ. If shares of XYZ go to $105 at expiration, owning the stock would give you a profit of $50. Owning the options, however, would give you a profit of roughly $500. The risk in call options, however, is that this increase in price needs to occur before the expiration date.
For more information about trading options, visit DayTradingModels.com
By: Greg Chan
About the Author:
Greg Chan is a business and finance expert. He is an active day trader and the author of several trading articles. For more information, visit DayTradingModels.com
Filed under Investing by Administrator