## Case for holding vested stock options?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
Posts: 808
Joined: Sat Jan 27, 2018 1:47 am
Location: Middle Earth

### Case for holding vested stock options?

Good evening, I'm hoping someone can help me understand this topic, as my own view on this has vacillated (or, perhaps more appropriately, oscillated) on this over the years, and I'd like to understand the mechanics.

Short version: Is it more beneficial to hold vested in-the-money stock options until expiration date?

Hypothetical scenario: Tranche of stock options are vested, with a grant price of \$40. Current FMV is \$135/share. Let's assume no practical concerns about liquidity, and let's ignore the concentrated risk of single-stock / employer stock.

(A) If one were to exercise and sell now, there would be \$95 of ordinary income recognized, and the net amount received would be \$66.50 assuming a 30% tax rate. If one were to then immediately reinvest this into another security, and saw a subsequent 15% gain in value, there would be about \$10 of unrealized capital gains (the future taxation of which is uncertain) -- i.e. the maximum net amount realized would be \$76.50.

(B) If one were to hold the vested stock options, and saw an identical 15% price appreciation as above, one could then exercise at a price of \$155. There would be \$115 of ordinary income recognized (\$155 minus \$40), and applying the same 30% tax rate, the net amount realized would be \$80.

It seems more lucrative to hold in this case, where all else is being held equal? Or am I missing something in my scenario that tilts the scales the other way?

Thank you,
DX
Jack FFR1846
Posts: 13571
Joined: Tue Dec 31, 2013 7:05 am
Location: 26 miles, 385 yards west of Copley Square

### Re: Case for holding vested stock options?

Here's what I think you're missing: You hold onto the options and the stock tanks. My real experience:

My options vested at \$38. Buy price \$13. I sold all and made enough money to pay off our mortgage and buy my wife a brand new car.

Co-worker had no doubt the stock would go to over \$100 as it had in the past. He held. The stock price slowly dropped, eventually getting to \$10. The products my coworker managed (telecom power products) in these early 2000's did what? Went in the toilet, if you don't remember. The stock did not recover, never came back and the coworker was let go. He did not pass GO, did not pay off his mortgage, did not buy his wife a new car.

I sell everything....options, RSUs, ESPP the milisecond I'm able to.
Bogle: Smart Beta is stupid
mrspock
Posts: 1593
Joined: Tue Feb 13, 2018 2:49 am
Location: Vulcan

### Re: Case for holding vested stock options?

Darth Xanadu wrote: Sun Apr 18, 2021 8:42 pm Good evening, I'm hoping someone can help me understand this topic, as my own view on this has vacillated (or, perhaps more appropriately, oscillated) on this over the years, and I'd like to understand the mechanics.

Short version: Is it more beneficial to hold vested in-the-money stock options until expiration date?

Hypothetical scenario: Tranche of stock options are vested, with a grant price of \$40. Current FMV is \$135/share. Let's assume no practical concerns about liquidity, and let's ignore the concentrated risk of single-stock / employer stock.

(A) If one were to exercise and sell now, there would be \$95 of ordinary income recognized, and the net amount received would be \$66.50 assuming a 30% tax rate. If one were to then immediately reinvest this into another security, and saw a subsequent 15% gain in value, there would be about \$10 of unrealized capital gains (the future taxation of which is uncertain) -- i.e. the maximum net amount realized would be \$76.50.

(B) If one were to hold the vested stock options, and saw an identical 15% price appreciation as above, one could then exercise at a price of \$155. There would be \$115 of ordinary income recognized (\$155 minus \$40), and applying the same 30% tax rate, the net amount realized would be \$80.

It seems more lucrative to hold in this case, where all else is being held equal? Or am I missing something in my scenario that tilts the scales the other way?

Thank you,
DX
This is the part you have wrong. If you sell and buy an index fund such as VTI, it's so diversified you never have to sell, you never have to pay capital gains. In retirement you can "nibble" on your nest egg, and the first \$40k of capital gains in retirement are taxed at \$0 if it's in a taxable account. Secondly, your heirs get a step up in the cost-basis upon your death (under current tax law), this zero's out the capital gains on anything they inherit. The advantages of diversification are too numerous to mention, but being able to hold "forever" is a big one, it changes everything.

You company stock on the other hand, it's going to go to zero. It might not be today, or tomorrow....or next year....but good chances in your lifetime it's going to zero dollars. You can't run the same math against a single stock due to the lack of diversification. You need to assume you are going to recognize the capital gains at some point to avoid financial suicide.

The only way I'd hold company stock is if I was really sure I was on a rocket ship and there was 5-8x appreciation in the very near future (e.g. within 5 years). Otherwise, I'd jettison every last penny of it.
curmudgeon
Posts: 2199
Joined: Thu Jun 20, 2013 11:00 pm

### Re: Case for holding vested stock options?

Selling options as soon as they vest is giving up a significant portion of the optionality value. Holding them runs the risk of losing the gains if the market (or company) tanks. I'm not sure there's a general answer. RSU and ESPP I tended to cash out as soon as available, but options were a different story. If I had options with modest gains when they vested and years to run, I generally sat on them. If I had options with large gains at vesting, I generally sold a portion (up to half), and retained the others until within a year or so of expiration (when I would try to market time my exit). Worked for me, and I didn't get into the "coulda, woulda, shoulda" when the stock later went one way or the other.
AlohaJoe
Posts: 5915
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

### Re: Case for holding vested stock options?

"Dear Bogleheads, let's assume I'm so good at stock picking that my company options will never go down and will even go up another 15% in the short term. Should I exercise the options? Or should I quit my job and become a hedge fund manager and make billions with my stock picking acumen? I'm on the fence."
Marseille07
Posts: 3487
Joined: Fri Nov 06, 2020 1:41 pm

### Re: Case for holding vested stock options?

It's really up to you. I usually like to do a trailing stop, so I can ride the upside while capping the downside.

But, given this is Bogleheads, majority of advice you receive would be to sell immediately and invest into VT or what have you.
random_walker_77
Posts: 1521
Joined: Tue May 21, 2013 8:49 pm

### Re: Case for holding vested stock options?

Darth, you are correct that in holding the option longer, you benefit (from leverage). You don't see that as much when you're deep in the money, as in your example, but it becomes really obvious if you're barely in the money. With the same \$40 exercise price, imagine that the current price was \$45. If it goes up by \$5 to \$50, it doubles in value. If it goes up another \$10 to \$60, then the value of your option doubles yet again. Once you're up to \$135, the leverage aspect drops off, but you still can see the impacts of that leverage. If it shoots up a lot more, then it gets closer and closer to behaving like a wholly-owned share of stock, as opposed to a call option.

BUT... leverage works both ways. At \$45, going up \$5 doubles the value. Going down \$5 wipes it out. At \$135, you'll still see that leverage effect on the downside too. If the stock drops by 50%, you're options holding falls by more than 50%. (As the stock drops from \$135 => \$65, your option's exercise value goes from \$95 => \$25)

Keep in mind the riskiness of a single stock holding... that is also the source of your paycheck. Keep in mind the safety of the "only free lunch in investing: diversification." But also keep in mind that a call option for 2 years out has value too, as can be seen in the call options that can be bought on the market (caveat: companies prohibit their employees from trading in derivatives on their company's stock). There's intrinsic value based on the probability that the stock price might rise sometime in the next n years. Employee options are special in that they can go out many years (for example 10 years), while normal options contracts are at most for a couple of years. On the other hand, your option probably expires if you're laid off, fired, or quit, so there's that.

I wouldn't recommend holding. But in a case of do as I say, not as I do, I should note that I've personally held when very confident in the company. I wouldn't recommend having more than 15% of net worth in the company. And you probably have additional equity vesting over time, which is yet another reason to cash out now. If things go badly, this is all you might get. If things go well, you'll still benefit from the newly-vested equity, so holding really is an artifact of greed (aka a risky bet on upside)
Topic Author
Posts: 808
Joined: Sat Jan 27, 2018 1:47 am
Location: Middle Earth

### Re: Case for holding vested stock options?

AlohaJoe wrote: Sun Apr 18, 2021 9:13 pm "Dear Bogleheads, let's assume I'm so good at stock picking that my company options will never go down and will even go up another 15% in the short term. Should I exercise the options? Or should I quit my job and become a hedge fund manager and make billions with my stock picking acumen? I'm on the fence."
I sincerely hope that your other 5,860 posts are not as unhelpful and fatuous as this one. Perhaps the community would be better served if you spent more time reading the posts than responding to them.
Topic Author
Posts: 808
Joined: Sat Jan 27, 2018 1:47 am
Location: Middle Earth

### Re: Case for holding vested stock options?

random_walker_77 wrote: Sun Apr 18, 2021 9:32 pm Darth, you are correct that in holding the option longer, you benefit (from leverage).
Thank you for your thoughtful response that addresses (and confirms) the basis of my question.
Tingting1013
Posts: 1246
Joined: Mon Aug 24, 2020 5:44 pm

### Re: Case for holding vested stock options?

Marseille07 wrote: Sun Apr 18, 2021 9:29 pm It's really up to you. I usually like to do a trailing stop, so I can ride the upside while capping the downside.

But, given this is Bogleheads, majority of advice you receive would be to sell immediately and invest into VT or what have you.
Actually no, the standard Boglehead advice on employee options is actually to hold them until close to the expiration date.

Time value and such. The opposite of the standard advice on RSUs and ESPP.
Marseille07
Posts: 3487
Joined: Fri Nov 06, 2020 1:41 pm

### Re: Case for holding vested stock options?

Tingting1013 wrote: Sun Apr 18, 2021 9:57 pm
Marseille07 wrote: Sun Apr 18, 2021 9:29 pm It's really up to you. I usually like to do a trailing stop, so I can ride the upside while capping the downside.

But, given this is Bogleheads, majority of advice you receive would be to sell immediately and invest into VT or what have you.
Actually no, the standard Boglehead advice on employee options is actually to hold them until close to the expiration date.

Time value and such.
I'm not an expert with options, but is there a difference holding ITM options until close to the expiration vs exercising now and holding the shares?
ivgrivchuck
Posts: 654
Joined: Sun Sep 27, 2020 6:20 pm

### Re: Case for holding vested stock options?

Marseille07 wrote: Sun Apr 18, 2021 10:00 pm
Tingting1013 wrote: Sun Apr 18, 2021 9:57 pm
Marseille07 wrote: Sun Apr 18, 2021 9:29 pm It's really up to you. I usually like to do a trailing stop, so I can ride the upside while capping the downside.

But, given this is Bogleheads, majority of advice you receive would be to sell immediately and invest into VT or what have you.
Actually no, the standard Boglehead advice on employee options is actually to hold them until close to the expiration date.

Time value and such.
I'm not an expert with options, but is there a difference holding ITM options until close to the expiration vs exercising now and holding the shares?
Yes there is a big difference unless the options are very deep in the money.
37% VTI | 37% VXUS | 13% I-bonds | 13% EE-bonds
willyd123
Posts: 219
Joined: Mon Feb 19, 2018 7:23 am

### Re: Case for holding vested stock options?

I used to administer the option plan for a major corporation. If I had a dollar for every finance guy who held on to his options to "maximize the deferral value" until the last year before expiry only to end up losing any appreciation, I would be very rich. Treat your options like ongoing compensation. You're probably getting grants every year anyway. Don't let the in-the-money option value became more than 5 or 10% of your total investment assets.
watchnerd
Posts: 8591
Joined: Sat Mar 03, 2007 11:18 am
Location: Seattle, WA, USA

### Re: Case for holding vested stock options?

Darth Xanadu wrote: Sun Apr 18, 2021 8:42 pm concentrated risk of single-stock / employer stock.
Is this hypothetical that you have options instead of RSUs?

I thought old school options for publicly traded companies had gone completely out of fashion.
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% Alts || LMP TIPS/STRIPS || RSU + ESPP
ScaledWheel
Posts: 170
Joined: Sat Jul 23, 2011 8:06 pm

### Re: Case for holding vested stock options?

watchnerd wrote: Mon Apr 19, 2021 6:46 am Is this hypothetical that you have options instead of RSUs?

I thought old school options for publicly traded companies had gone completely out of fashion.
They could be at a now-public startup, or like my spouse, at a large (Fortune 500) company whose equity compensation include both RSUs and options.

What we do for the stock is sell half of the value of the equity at the latest vesting date of the year and put a trailing stop loss on the other half of the equity.

This works well in practice for us. As an example

Year 1: Receive \$10k, sell half and put trailing stop loss of 20% on the other half.
Year 2: Receive another \$10k, but the \$5k held from last year has appreciated to 7k (we got lucky). Sell 17/2 = 8.5 k, put trailing stop loss on that 8.5k.
Year 3: Receive another \$10k, no appreciation in stock, so sell 18.5k/2 = 9.25k, etc.
Year 4: repeat...

If there's a loss, which hasn't happened yet but is sure to at some point, then we've at least limited our downside and still capture some upside.

The math is obviously a bit different for options. If the options are deep in the money, then we just exercise and take the gains. If not, we "let it ride". We need to come up with a better rule for this. I actually haven't looked into whether or not we can do the trailing stop loss for options as we've only received one batch so far, but if so I would probably go that route as well.
diy60
Posts: 556
Joined: Wed Sep 07, 2016 6:54 pm

### Re: Case for holding vested stock options?

watchnerd wrote: Mon Apr 19, 2021 6:46 am
Darth Xanadu wrote: Sun Apr 18, 2021 8:42 pm concentrated risk of single-stock / employer stock.
Is this hypothetical that you have options instead of RSUs?

I thought old school options for publicly traded companies had gone completely out of fashion.
My Megacorp employer granted both RSUs and options for a couple of decades and then phased out of granting options. Employees preferred the RSUs over that of options because if you had a slow decade the options could expire worthless, whereas with the RSUs at least you had the vested amount (assuming you sold at vest).
dbr
Posts: 35607
Joined: Sun Mar 04, 2007 9:50 am

### Re: Case for holding vested stock options?

I had options for fifteen years and followed a practice of exercising just before expiration. I think in a large stable company where this is a long term plan for continuously rolling over the tranches it makes sense. If I had a large one time option significantly in the money I would think twice.

As with others they eventually chose RSUs and for myself that was really better. If the idea is to pay out some compensation in stocks that you sell immediately then so be it. No one needs the risk of being tied to company stock, the above paragraph notwithstanding.
Topic Author
Posts: 808
Joined: Sat Jan 27, 2018 1:47 am
Location: Middle Earth

### Re: Case for holding vested stock options?

dbr wrote: Mon Apr 19, 2021 8:00 am I had options for fifteen years and followed a practice of exercising just before expiration. I think in a large stable company where this is a long term plan for continuously rolling over the tranches it makes sense. If I had a large one time option significantly in the money I would think twice.

As with others they eventually chose RSUs and for myself that was really better. If the idea is to pay out some compensation in stocks that you sell immediately then so be it. No one needs the risk of being tied to company stock, the above paragraph notwithstanding.
Thank you for your thoughts. From a practical perspective, I can't disagree.

I'm trying to understand the option premium, in the sense that a 1% increase in share price for a security in which in-the-money vested options are held translates into something greater than a 1% return on a plain ol' equity holding. How do I define that premium (I assume it's a function of the grant and exercise price)?
dbr
Posts: 35607
Joined: Sun Mar 04, 2007 9:50 am

### Re: Case for holding vested stock options?

Darth Xanadu wrote: Mon Apr 19, 2021 8:41 am
dbr wrote: Mon Apr 19, 2021 8:00 am I had options for fifteen years and followed a practice of exercising just before expiration. I think in a large stable company where this is a long term plan for continuously rolling over the tranches it makes sense. If I had a large one time option significantly in the money I would think twice.

As with others they eventually chose RSUs and for myself that was really better. If the idea is to pay out some compensation in stocks that you sell immediately then so be it. No one needs the risk of being tied to company stock, the above paragraph notwithstanding.
Thank you for your thoughts. From a practical perspective, I can't disagree.

I'm trying to understand the option premium, in the sense that a 1% increase in share price for a security in which in-the-money vested options are held translates into something greater than a 1% return on a plain ol' equity holding. How do I define that premium (I assume it's a function of the grant and exercise price)?
The extreme example would be a strike price of \$101, the stock trading at \$100 and the option worth \$0. If the stock goes up 10% to \$110, then the value of the option becomes \$9, an infinite gain. More realistic math would be a strike price of \$101, the stock trading at \$105 and the option worth \$4. If the stock goes up to \$110, which is 4.8% gain, the option is now worth \$9, a gain of \$5 or 125%. That is what being leveraged on underlying stock price means. The leverage works the other way, of course, except that it is limited to the condition that the option becomes worthless if the stock price falls too or below the strike price, which is where it started the day it was granted.
knowledge
Posts: 335
Joined: Wed Mar 02, 2011 5:44 pm

### Re: Case for holding vested stock options?

For every anecdote about FOMO/exercising options too late, you'll find others mentioning the other side. To boot, I have left now \$5M+ on the table by exercising options too early and have realized <10% of their maximal value. Who in their right mind could have guessed?

So long as you can afford to, holding on to maximize the time value of the option is likely worth it, but it'll be a roller coaster.
Marseille07
Posts: 3487
Joined: Fri Nov 06, 2020 1:41 pm

### Re: Case for holding vested stock options?

ivgrivchuck wrote: Mon Apr 19, 2021 2:52 am
Marseille07 wrote: Sun Apr 18, 2021 10:00 pm
Tingting1013 wrote: Sun Apr 18, 2021 9:57 pm
Marseille07 wrote: Sun Apr 18, 2021 9:29 pm It's really up to you. I usually like to do a trailing stop, so I can ride the upside while capping the downside.

But, given this is Bogleheads, majority of advice you receive would be to sell immediately and invest into VT or what have you.
Actually no, the standard Boglehead advice on employee options is actually to hold them until close to the expiration date.

Time value and such.
I'm not an expert with options, but is there a difference holding ITM options until close to the expiration vs exercising now and holding the shares?
Yes there is a big difference unless the options are very deep in the money.
OP's situation as described is very deep ITM (\$40 strike and \$135 FMV).

Besides, the "difference" we're talking about is "holding options until close to the expiration date" vs exercising today and holding the underlying until close to the expiration date. Personally, I don't see much difference but I'd like to learn if any.
milktoast
Posts: 361
Joined: Wed Jul 10, 2019 8:17 pm

### Re: Case for holding vested stock options?

Marseille07 wrote: Mon Apr 19, 2021 9:25 am OP's situation as described is very deep ITM (\$40 strike and \$135 FMV).

Besides, the "difference" we're talking about is "holding options until close to the expiration date" vs exercising today and holding the underlying until close to the expiration date. Personally, I don't see much difference but I'd like to learn if any.
In my opinion, exercise and hold is not the right strategy in almost all situations. Including this one. The one exception is if you can use an 83b election on seed or A-round options.

If you exercise and hold for over a year and the price goes up you'll have a 15% reduction in taxes on the additional gain. But you have paid \$40 per share which would have otherwise been invested elsewhere. So it isn't a strict 15% savings.

I know it's off topic, but for the OP I would look at your upcoming RSU/option vests. And imagine two scenarios - stock doubles or stock halves. And use this for picking a chunk size to sell.

For doubling, assume you'll vest everything in your pipeline then figure out the total money you'll make if you sell at 2x the current price. Compare that to how much money you'll make if you sell a given size chunk at current price and the rest at 2x. Then for halving, assume you will be laid off and grants stop. Figure out the total money you'll make if you hold vs sell a given chunk.

In my past, that has helped me figure things out.

For RSU, it's usually a no brainer to sell what you have vested. The pipeline tends to outweigh each chunk. But if it was fully vested \$40 options on a \$44 stock, the calculus is very different.

For \$40 options on a \$135 stock, I think it's starting to look like RSU. You are deep in the money and leverage isn't as strong.
Marseille07
Posts: 3487
Joined: Fri Nov 06, 2020 1:41 pm

### Re: Case for holding vested stock options?

milktoast wrote: Mon Apr 19, 2021 9:57 am
Marseille07 wrote: Mon Apr 19, 2021 9:25 am OP's situation as described is very deep ITM (\$40 strike and \$135 FMV).

Besides, the "difference" we're talking about is "holding options until close to the expiration date" vs exercising today and holding the underlying until close to the expiration date. Personally, I don't see much difference but I'd like to learn if any.
In my opinion, exercise and hold is not the right strategy in almost all situations. Including this one. The one exception is if you can use an 83b election on seed or A-round options.

If you exercise and hold for over a year and the price goes up you'll have a 15% reduction in taxes on the additional gain. But you have paid \$40 per share which would have otherwise been invested elsewhere. So it isn't a strict 15% savings.
Interesting, thanks for the explanation. It's been a decade since I last had stock options. These days companies dish out RSUs.
ivgrivchuck
Posts: 654
Joined: Sun Sep 27, 2020 6:20 pm

### Re: Case for holding vested stock options?

Marseille07 wrote: Mon Apr 19, 2021 9:25 am OP's situation as described is very deep ITM (\$40 strike and \$135 FMV).

Besides, the "difference" we're talking about is "holding options until close to the expiration date" vs exercising today and holding the underlying until close to the expiration date. Personally, I don't see much difference but I'd like to learn if any.
That is so deep in the money that it almost behaves like an RSU. So yeah, exercising immediately would be the bogleheads approach.

Black scholes model shows that the remaining time value is only ~3 dollars which is negligible.
https://www.mystockoptions.com/black-sc ... =Calculate
37% VTI | 37% VXUS | 13% I-bonds | 13% EE-bonds