One of the perks of working with a company that offers benefits such as paid time off, health insurance, or a retirement plan, may come in the form of stock options. These are increasingly offered as you climb your career ladder at places like tech companies.
But what are stock options? And why should you care? Maybe this is a perk that you glance over because “you're not an investor.” Or the stock paperwork seems complicated.
In fact, a recent survey from Schwab shows that “76 percent” of employees never exercise their stock options or sell shares that are part of their compensation. Half of them say they fear they will make a mistake when selling them.
However, stock options can be easy to grasp, and Merino Wealth wants to help you take control of this great financial benefit. Here is everything you need to know about them, and how you can use them to your advantage.
What are stock options?
Stock options are a type of financial contract that gives the holder the right, but not the obligation, to buy or sell shares of a stock at a set price within a certain time period. An employer that offers stock options allows their employee to buy at a “strike” price, usually below market value.
According to an estimate by the National Center for Employee Ownership, employees who utilize their stock option receive an amount “between 12 and 20%” of their salaries. This is from the time they pay for them and when they sell them.
How do stock options work?
The option holder buys their shares of stock in accordance with their “strike” price, stock shares amount, and timeframe guidelines. If the stock price goes up, the option holder can make money by selling their shares at a higher price than they paid for them. And if the stock price goes down, the option holder can still sell their shares, but they will make less money.
For example:
Say your company lets you buy 1,100 shares of stock at $20 a share (1,100 x $20 = $22,000).
And the current market value of a stock is $50.
If you decide to sell all 1,100 shares at the current market price (1,100 x $50 = $55,000).
You would instantly profit $33,000 ( $55,000 - $22,000 = $33,000).
When the stock is trading above the exercise price this type of option is considered to be “in the money.” So now that you understand how they work, you’ll have to evaluate if they work for you?
Should you consider stock options as part of your compensation?
Taking into account the pros and cons of stock options as part of your compensation, depends on how they align with your goals. Here are a few things you'll want to consider in making an informed decision.
The type of company that gives them - Publicly traded companies tend to have more accessibility to exercise your options and then sell your shares quickly as opposed to private companies that might not have the same access yet.
The strike price - The lower the strike price, the more "in the money" the option is, meaning it has a greater chance of being profitable.
Time until expiration - Longer expirations give the stock more time to rebound if it falls and also offer protection against sudden market changes.
Your personal financial goals - Stock options can increase your overall net worth or help you save for retirement.
How can I use stock options to my advantage?
Stock options are overall a great asset and give you a stake in the company. The work you do can directly increase the value of the stocks.
Your performance reflects the company’s outlook, which in turn raises the value of the stocks.
This means a better outcome for you when you decide to sell.
Here is how some of Merino Wealth’s clients increased their wealth with stock options:
We have some clients working at the McDonald’s corporate headquarters here in Chicago and have seen a pretty decent uptick in the stock price since the pandemic started. With their tenure at the company, some of them had been holding on to options for years while we continued to monitor the progress.
During the pandemic, some of these options went from a break-even to all of a sudden being “in the money.” The timing of this worked out well for one client who was looking to move from the city to the burbs during this time so we exercised a portion of his options to fund a portion of the down payment on his family’s new home.
Over at Netflix, we have clients who are eligible for a company benefit that allows employees to purchase stock options utilizing a portion of their salaries. The exercise price of these options is the closing price of Netflix stock on the day that the options are granted, which is the first trading day of the month.
In the past year, the stock has dropped by nearly 60%, so these clients are purchasing options with a strike price around $200/share. If Netflix increases back to its 52-week high of $700.99/share then these shares will be “in the money” beyond an amount that we would’ve predicted during enrollment.
Of course, it’s also possible that the share price won’t increase that dramatically, so we’ll need to keep an eye on things to help our clients determine if it makes sense to exercise their options at any point in the future. And we definitely don’t want to count on receiving these funds until we’ve successfully exercised these options.
With that said, if you want help figuring out the best strategy for your stock options, evaluating a potential job offer, or anything finance-related, visit Merino Wealth and see if we can help.