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How to Manage Your Emplyee Stock Options

|Includes: Apple Inc. (AAPL)

                                                                                    Article for July 13, 2009

How to Handle Your Employee Stock Options

There are an estimated 10 million employees in the USA who own or

are grantees of employee stock options and related hybrids as compensation.

There are also tens of millions worldwide outside of the USA.

Most of the employees have seen the value of the employees stock

options decimated over the past two years as stock values have tumbled.

Its not unusual to see the value of ESOs decline 80-90% with a 40-60%

drop in the stock. Was there something that could have been done to

reduce the extreme risks to which these employees were subjected?

The answer is absolutely yes. But very very few grantees, be they

executives or managers or low level employees know how, regardless

of the prominence of their investment advisors or wealth managers.

This article is about how a professional options market maker would

 handle the risks of holding employee stock options granted by major

 U.S. companies. You will find this information nowhere else.

The strategy is simple for highly experienced professional options traders

 but not so simple for most readers. To actually execute the strategy

requires some understanding of the options concepts and relevant IRS

tax laws. Officers and directors should understand relevant Securities

Statutes and SEC Rules.

This article will create  real life situations in several stocks  in future

articles and show you how to manage  those positions like an expert.

Our First Example is Apple Computers

    •    Apple Computer is trading at $138.52 on July 11, 2009.
    •    Assume you own 1000 shares fully paid for:  Stock value equals $138,520.
    •    Assume you own vested non-qualified ESOs to buy 3000 shares of stock
            at 70 with 5 years to expiration. Fair Value of ESOs equals $264,000

Write calls

The Jan 2011, 160 LEAP calls can be sold for about $20.25 each.

Sell 20 calls and tell the broker to send you the $40,500. Of the 20

calls sold, 10 are "qualified covered calls" and 10 are designated as

"hedging transactions" under IRS section 1221. There is no

tax due or interest to be paid, since there is no "income" or borrowing.

The deposit of the stock is sufficient as a margin requirement.

Gain or loss on the sale of the 10 "qualified covered calls" are short

term capital gain or loss. Gain or loss on the sale of 10 calls of the

"hedging transactions" are ordinary gain or loss.

Risk reduced

You have reduced your risk by about 40%. There has been no forfeiture

of time premium. Your alignment of interest has been reduced about 40%.

The position is substantially bullish. If we wished to reduce more risk we

would sell more calls or buy a few puts.

More examples weekly:

We will follow the suggested Apple positions with weekly updated articles and add

more stocks next week and beyond. There is no other place you can go to

learn how to expertly handle your employee stock options. By following the

processes of hedging with calls and puts and then the adjusting of  those

positions accordingly,

You may be able to soon  do it on your own.


John Olagues

John Olagues is a former member of the CBOE and the PSE for a total of over ten years, where he personally held the largest positions and traded more options than any other trader.