Is it better to exercise stock options high or low?

Question

Let's say I have 100 shares of Yahoo stock options at $5 per share, and another 100 shares at $20 per share.

Yahoo's current stock price is $25, the market expects it to rise to $35 next year.

Is it better to exercise now while the price is low? Or is it better to wait till the price is high?

Is it better to exercise the cheap $5 ones first?

(Better meaning making the most profit / holding the most stocks after exercise / paying the least taxes.)

Answer 1

LOL do you work for Yahoo? :P

Answer 2

Geez, these people are no help at all. We don't trade options for the "tax breaks." LOL

You have your terminology mixed up, and you don't give us much to go on, but let me try to fill in the blanks.

First, a stock option always covers 100 shares of the stock, and I don't think you are talking about 100 option contracts. You have one call option from when the stock price was $5/sh, and you bought another single call option when the stock price was $20/sh. I'm also going to assume you are talking about being long calls.

Apparently you do not currently own the stock, but you want to, correct? That is why you would exercise the option, to "call in" the stock. So you're asking at what price is the best time to do that?

Once the stock price goes "in-the-money" there is little advantage to owning an option. The delta of the option becomes 1.00, and the option price moves in lockstep with the stock price. That's why options are almost always exercised as soon as they approach a delta of 1.00

You buy options for the leverage, correct? When the leverage goes away, there's no point in owning an option.

You have a lot to learn, and should wait a year or two and get an option evaluation program before you dabble in this extremely dangerous market. Buying options is a fools game. That was never their intent. They were designed as a hedging vehicle, and they were designed to expire worthless. That's why 85% of all options expire worthless, that is the intent. When you buy an option, you have just reversed the odds against yourself -- double, or triple.

You've seen the incredible leverage and are already counting up how much money you can make; thus the silly question. Better to concentrate on risk management and good money management, or just go to Vegas and at least enjoy losing your money.

Answer 3

There are many strategies with stock options, and there may be particular facts in your situation that change the general rules, so please proceed with caution if following what I am saying below.

From your last paragraph, it sounds like you still want to hold the stock after you exercise, but you want to pay for the stock you buy by cashing out enough of the stock to cover the purchase cost. In this case, if you expect the price of the stock to rise, you are usually best off NOT exercising until the options are close to expiring.

As an example, ignoring taxes, if you cash the $5 options and sell 20 shares to pay the $5,000 purchase price, then later you will have 80 shares to sell at $35. You'll end up with $2,800. If you wait and exercise when the price is $35, you would have 100 shares x ($35-$5)=$3,000.

On the other hand, if you expect the price to drop, you are better off exercising and cashing everything out now.

After taxes are factored in, the results are generally the same. Exercising and cashing out enough to pay for the options is usually not the best way to go unless the options are near to expiration.

If you do decide to exercise options, it is usually best to cash the cheap ones first. The main exception is when the more expensive ones expire sooner than the cheap ones.

Answer 4

You're joking, right? Regardless of your tax rate, you'll always have more money in your pocket by going for the most profit.

But check with your tax advisor. Some option transactions can trigger an AMT event. The IRS loves those as they mean LOTS of extra tax $$$ for them to collect.

Guessing what the future price will be is pure speculation. The market doesn't always get what it expects!

Answer 5

CloneofSnake, there are a number of different types of options, and you did not specify which kind you are talking about.

I'll answer your question by assuming that you are talking about qualified employee stock options, which were granted to you for free from your employer. If we are really talking about only 200 shares of stock, then your stakes do not seem to be very high, but just to answer your question I will answer as if the stakes were high.

It is difficult to answer your question without a lot of qualifications, precisely because Yahoo stock is volitile and speculative, and the general market is not trending very well at the moment.

I will explain to you a number of scenarios, and then you decide what you want to do. But first please understand that "most profit" and "least taxes" are NOT your only objectives--at least, they shouldn't be. Please don't be like the young man in California who owes the IRS $8 million that he doesn't have, because he exercised and held stock options trying to get long-term capital gain rates (15% in his case), but he was assessed taxes on the market value at exercise time (probably not qualified stock option grant), and while he was holding the stocks they became worthless when his dot-bomb employer went bankrupt.

If you have qualified stock options in a blue-chip company (ie, less likely to go bankrupt), and if you are talking about quantities of stock that you can handle without borrowing to exercise them or using up every last penny of your savings, then the best strategy is to buy them and hold them for ONE YEAR AND ONE DAY to pay the lower long-term capital gains rate. Then you can sell them whenever you feel that the stock has reached your target. Many stocks pay dividends, and if Yahoo did (I don't think it does!!), you could collect that during your holding period. But I do not think that issue is relevent to your question; I bring it up only because some day you might need to answer the question for a company that does pay a dividend.

>>Is it better to exercise now while the price is low? Or is it better to wait till the price is high?

The relevent considerations are actually the holding period (at least one year and one day will get you lower long-term capital gain rates) and the difference between your strike price and the market price. Your holding period is the time AFTER you exercise the options and BEFORE you sell them. 1 year plus one day (don't forget the ONE DAY).

>>Is it better to exercise the cheap $5 ones first?

It depends on when you sell them more than when you buy them. These will be taxed the most because they will have the biggest difference between stock price and market price (ie, they will have been the most profitabe for you)--assuming that the stock price actually goes up! Therefor, if practical, you might want to arrange to sell the stock you bought with $5 options during a year when your marginal tax rate is relatively low compared to other possible windows of opportunity. For example, if you knew that you would have less income some year, you might want to target their sales in that year.

>>the market expects it to rise to $35 next year

Irrelevent. It will do whatever it's going to do. Nobody can guarantee you what it is going to do. It could go down MORE. Or it could turn around, or it could rise for a year and then plunge just before you got ready to sell. I don't know. You don't know. Beware.

Now, because we are talking about the stock of a company that is relatively speculative, I personally would wait, because I can not see any advantage to buying them now, other than to get the long-term-capital-gains clock started ticking.

Read the details of your stock option grant to find out what the terms are. Make sure you understand clearly when they expire, and what happens if you are suddenly terminated (you should have some number of days or weeks to exercise them, but you should know exactly what those terms are).

This answer is given for educational purposes only and does not constitute advise to buy, sell, not buy, or not sell options. Do your own due dilligence.

Answer 6

1

Answer 7

Not enough information to get you the correct answer.

Who is this market character that expects things? Who does he speak to you through? That guy is probably pulling your leg.