Options Still Lucrative

Stock options aren’t what they used to be back in the day, when a “Microsoft millionaire” and “Microsoft employee” were basically synonymous, and when tech people in general thought of early retirement as age 30. But as a part of some clients’ assets, they remain potentially important, as well as misunderstood, and in some cases emotionally charged. Because of that, the discussion with clients about options can be almost as important as the analysis itself.

Options are less popular today for a number of reasons. They need to be expensed on company income statements, whereas in the past it was possible to simply footnote them. A lack of understanding about options has prompted companies to move toward restricted stock and other alternatives. Two major market corrections in 15 years didn’t help, since they left boatloads of options underwater.

“This was a catastrophic problem across industries as a result of the 2008-09 recession,” says Scott Feraro, founder and managing director of Pepin Consulting.

Stock options still can be very lucrative if handled properly. But there are situations in which people can easily make mistakes with them. These may be the most common:

They exercise the options early for no good reason. Over the years, I’ve met a number of people with options who essentially told me that their strategy had been to exercise in-the-money options as soon as they vested, regardless of the price. Ouch. The reasons varied, but the option holders shared a misunderstanding of the vehicle. Fortunately, our clients should be talked out of making that mistake by their advisor in the vast majority of situations. Outside of extraordinary cases like a financial emergency (or, of course, pending expiration), it is hard to think of why it would make sense to exercise an option that is only narrowly in the money.

In educating clients about options and their potential value, it can be helpful sometimes to employ the analogy of a real estate mortgage. “Suppose a bank was willing to lend you 100% of the purchase price on a new home, at zero interest, and with the provision that if the home fell in value by half you could mail back the keys, no questions asked and with no damage to your credit rating. What would you think of that deal?”