When the economy is strong and the markets are performing well, stock options are an attractive form of compensation that can help companies attract and retain talent. But, when the market takes a turn for the worse or the company’s stock price drops, employees can find themselves holding underwater stock options, which can be nerve-wracking and demoralizing. If you find yourself in this situation, you may be wondering: do these options have any value? While underwater options may seem worthless, there are a few things to consider before you give up on them.
Understanding Underwater Stock Options
Firstly, it’s important to understand what it means for stock options to be “underwater.” Stock options give employees the right to purchase company stock at a predetermined price, known as the exercise or strike price. If the current market price of the stock is below this strike price, the options are underwater, as exercising them would result in a financial loss.
Financial Planning Considerations
Whether or not you should hold onto your underwater options depends on your individual circumstances:
Assess the Company’s Potential: Evaluate the long-term prospects of the company. If you believe in the company’s potential for growth, it may be worth holding onto your options in the hope that the stock price will rebound.
Time Horizon: If you are planning to retire in the near future, it may not make sense hold onto underwater options. But, if you have a long-term investment horizon, you have more time to wait for the stock price to recover.
Diversification: Consider the role of these stock options in your broader financial portfolio. Holding a significant amount of your wealth in a single company’s stock can be risky. Work with a financial advisor to assess how these options fit into your overall investment strategy and adjust as necessary to ensure a diversified portfolio.
Liquidity and Cash Flow: Evaluate your liquidity needs and cash flow. Exercising stock options often requires a cash outlay, and if the options are underwater, you may be better off conserving cash for other financial goals or investment opportunities.
Tax Considerations
Tax Treatment of Stock Options: Understand the tax implications of your stock options. Non-qualified stock options (NSOs) are taxed as ordinary income when exercised, while incentive stock options (ISOs) may qualify for more favorable capital gains tax treatment if certain holding period requirements are met.
Alternative Minimum Tax (AMT): For ISOs, be aware of the potential Alternative Minimum Tax (AMT) implications. Exercising ISOs can trigger AMT, which could result in a significant tax liability, even if the options are underwater.
Tax Planning Strategies: Explore tax planning strategies with your financial advisor and tax professional. In some cases, it may be advantageous to exercise underwater options in a year when you have lower income to minimize tax liability. Additionally, if you believe the stock price will rebound, exercising the options and holding the stock for at least one year can qualify you for long-term capital gains tax treatment on any future appreciation.
Conclusion
While holding underwater stock options can be disheartening, it’s important to take a holistic view before making any decisions. Evaluate the long-term prospects of the company, consider the role of these options in your broader financial portfolio, and work with a financial advisor and tax professional to navigate the complex tax landscape. With careful planning and strategic decision-making, you may be able to find value in your underwater stock options and align them with your overall financial goals.