When should you exercise stock options?
It only makes sense to exercise your options if they have value. If they do, they're known as “in-the-money.” This happens when the strike price (or exercise price) of your stock options is lower than the market price of your company shares trading on the exchange.
If you believe the stock price will rise over time, you can take advantage of the long-term nature of the option and wait to exercise them until the market price of the issuer stock exceeds your grant price and you feel that you are ready to exercise your stock options.
The holder of an American-style option can exercise their right to buy (in the case of a call) or to sell (in the case of a put) the underlying shares of stock at any time. The holder of a European-style option can only exercise their right at expiration.
A put option is a contract that gives its holder the right to sell a number of equity shares at the strike price, before the option's expiry. If an investor owns shares of a stock and owns a put option, the option is exercised when the stock price falls below the strike price.
Remember that you never want to exercise your shares when the Fair Market Value (FMV) is below the exercise price; these shares are in theory “under water”, or of no monetary value to you. The other very important fact that you need to understand is what type of option you have been granted.
If your startup is entering acquisition negotiations, it can be financially prudent to simply wait to see how the acquisition shakes out. The major benefit to exercising stock options pre-exit is to take advantage of long-term capital gains.
There are two types of options: American and European options contracts. American options can be exercised at any time up to and including the expiration date of the option. However, European options can only be exercised on the date of expiration. Options can expire either in the money (ITM) or out of the money (OTM).
What does it mean to exercise stock options? Exercising stock options means you're purchasing shares of a company's stock at a set price. If you decide to exercise your stock options, you'll own a piece of the company. Owning stock options is not the same as owning shares outright.
Early exercise of an option can make financial sense in some cases, such as when the stock is close to its strike price or the option is nearing its expiration date, or when selling an employee option early can help you avoid the alternative minimum tax (AMT).
Early exercising allows you to purchase your stock options before they vest when the strike price and FMV are equal or negligible, so you trigger very little or no additional taxes when exercising.
What is the best way to use stock options?
To exercise a stock option involves buying (in the case of a call) or selling (in the case of a put) the underlying at its strike price. This is most often done before expiration when an option is deeply in the money with a delta close to 100, or at expiration if it is in the money at any amount.
You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.
In this case, your options could expire worthless. While you wait, don't forget to keep track of the expiration date. Unfortunately, options with value can end up wasted if not exercised in time.
By exercising a call early, you may be leaving money on the table in the form of time value left in the option's price. If there is any time value, the call will be trading for more than the amount it is in-the-money.
Exercising employee stock options is like purchasing shares in any other company. You now own a small piece of equity in your employer, and it's up to you to decide how and when you will sell those shares, ideally at a profit.
Option holders have until 5:30 p.m. Eastern Time on the business day immediately prior to the expiration date or, in the case of Quarterly Options Series, on the expiration date, to make a final decision to exercise or not exercise an expiring option.
A cashless exercise, also known as a "same-day sale," is a transaction in which an employee exercises their stock options by using a short-term loan provided by a brokerage firm. The proceeds from exercising the stock options are then used to repay the loan.
Exercising Options
Increases chance of risk: margin call, stock's value could decrease. In general, traders can make a greater profit via closing positions — by buying or selling options rather than exercising them.
The safest option strategy is one that involves limited risk, such as buying protective puts or employing conservative covered call writing. Selling cash-secured puts stands as the most secure strategy in options trading, offering a clear risk profile and prospects for income while keeping overall risk to a minimum.
If you are looking for an option selling strategy that has unlimited profits with limited risks, then the synthetic call strategy is the best way to go. As part of this strategy, the trader purchase put options on the stock that they are holding and which they think will rise in the future.
How do options work for dummies?
A call option gives you the opportunity to profit from price gains in the underlying stock at a fraction of the cost of owning the stock. Put option: Put options give the owner (seller) the right (obligation) to sell (buy) a specific number of shares of the underlying stock at a specific price by a specific date.
You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.
Exercising your stock options early initiates the holding period for long-term capital gains taxes, which could lower the taxes you owe upon selling in the future if your equity's value increases.
Stock options are typically taxed at two points in time: first when they are exercised (purchased) and again when they're sold. You can unlock certain tax advantages by learning the differences between ISOs and NSOs.
Exercising stock options means you're purchasing shares of a company's stock at a set price. If you decide to exercise your stock options, you'll own a piece of the company. Owning stock options is not the same as owning shares outright.
