4 Mistakes People Make With Stock

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1 Page 1 of 5 This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit MARKETS JOURNAL REPORTS 4 Mistakes People Make With Stock Options It can be a cherished perk to be awarded options by your company. But don t blow it. ILLUSTRATION: JASON SCHNEIDER FOR THE WALL STREET JOURNAL By VERONICA DAGHER July 6, :05 p.m. ET

2 Page 2 of 5 Company stock options can be a source of great wealth. They can also be a source of great confusion. All too often, people don t read statements about how their options work whether because the explanations seem opaque or there simply aren t enough hours in the day to squeeze in another chore. And that can lead to big problems, because options come with many complex rules attached and ignoring them can have serious consequences for people s portfolios. People can end up facing substantial tax hits, taking on unnecessary risk or even losing the right to exercise the options entirely. Below, financial advisers weigh in on some of the risks and fine print that people frequently overlook. 1. The company can change the terms of your options. When employees are fired or retire, many companies change the terms of their options, so they have less time to exercise them. This means the employee has less time for the options to appreciate in value or recover if underwater. In a worst-case scenario, the options would simply expire and the employee would be none the wiser. Employees who aren t aware of these provisions may find a great deal of their option wealth expiring in a short period, says John Voltaggio, managing director at Northern Trust in New York. For example, Mr. Voltaggio worked with an executive who was retiring. The executive learned that certain option grants wouldn t fully vest, and of his vested options, their term was reduced. As a result, the 100,000 options granted to him shrank to 60,000 leaving him with significantly less net wealth than he had planned on, and less time to exercise the options. Had he been aware of the terms of the options, Mr. Voltaggio says, he would have begun to exercise them sooner. 2. You need a strategy to make options work. People too often believe that their company s stock will continue to increase in value and they can wait until the last minute to exercise their options, says Joe Heider, founder of Cirrus Wealth Management in Cleveland. But many times, such as what happened to many folks options in 2008, the option will actually fall out of the money and expire worthless, he says.

3 Page 3 of 5 JOURNAL REPORT Insights from The Experts ( Read more at WSJ.com/WealthReport ( mg=inert-wsj) MORE IN INVESTING IN FUNDS & ETFS Investors Brace for Fewer Winners ( ) Where Are the Female Fund Managers? ( Q&A on College Financing ( Cold Water on a Hot Insurance Product ( U.S.-Stock Funds Rose a Hair in Quarter ( Consider a client of Sandra Bragar, who is director, wealth management at Aspiriant in San Francisco. The client lost track of her stock options expiration date and then needed to act quickly to exercise them. But the client was a high-level executive at a publicly traded company subject to Securities and Exchange Commission filing requirements. And the trading window for insiders wasn t going to be open before the stock options expired. So the client was forced to exercise and hold the stock options, when she otherwise would have preferred to sell them and she had to come up with $200,000 to cover the exercise price. She didn t have that much cash available and was forced to use margin. Things ended well, Ms. Bragar says: When the trading window opened a couple of months later, the client sold the shares and paid off the margin loan. But things could easily have gone badly. If the stock had taken a big tumble between the time of exercise and the delayed sale date, the client would have been forced to cover the margin out of her own pocket. Keep track of option expiration dates and develop an exercise plan for them at least 12 months in advance, says Ms. Bragar.

4 Page 4 of 5 3. Options aren t stocks. Many people don t realize options are inherently riskier than common shares, says Mr. Voltaggio. When employees look to diversify, they often sell their common shares before exercising options that are worth money. This can be a mistake, Mr. Voltaggio says. Why? While options carry a great deal of upside leverage, they can also expire worthless during a downturn in the market. This can be an especially big mistake if an oversize portion of your retirement savings is concentrated in your company s stock options, says Paul Palazzo, managing director at Altfest Personal Wealth Management in New York. In contrast, if you hold common shares, they can recover their value over time. There are other reasons to hold on to stocks rather than options. Common shares may pay a dividend, whereas options never do. And the appreciation realized in the option will be subject to ordinary income tax, but the appreciation in common shares faces capital-gains tax treatment, Mr. Voltaggio says. He advises exercising options 75% of the way through their term a reasonable period of time to allow the options to realize their potential, but not too close to expiration, where a short-term drop in price could render them worthless. 4. Not all options are taxed the same. The most common type of stock-option grants are nonqualified stock-option grants, which are subject to regular income tax when they re exercised. However, some people also receive qualified or incentive stock options, known as ISOs. PHOTO: ISTOCKPHOTO/GETTY IMAGES

5 Page 5 of 5 The spread on these options isn t subject to regular income tax, but to secure the more favorable taxation, the options are subject to a greater number of rules and restrictions that many people aren t aware of, Mr. Voltaggio says. For example, while ISOs can avoid regular income tax, the spread on ISOs is subject to the alternative minimum tax. Also, people need to hold the shares received upon an ISO exercise for a least one year from the date they were exercised and at least two years from the date they were granted to maintain the favorable tax treatment, Mr. Voltaggio says. If people sell their stock before meeting those minimums, the spread will be subject to ordinary income tax, he says. Ms. Dagher is a reporter at The Wall Street Journal in New York. her at veronica.dagher@wsj.com. Copyright 2014 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit