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