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Wall Street Journal, February 10, 2004
Stock Options Make a Comeback
As Market Rebounds, Number of Employees Cashing In Shares Jumps; Timing Your Move
By Ruth Simon
10 February 2004
The Wall Street Journal
(Copyright (c) 2004, Dow Jones & Company, Inc.)
THE NUMBER of employees choosing to exercise their stock options has sharply increased in recent months, as the rising stock market makes it more attractive to cash them in.
The money being pocketed doesn't approach the massive sums of the late 1990s when surging stock prices turned ordinary workers at some companies into millionaires. Nonetheless, the increase represents a huge turn-around from the past three years when many employee options were so far Under water that it didn't make sense even to think about exercising them.
More than 14 million American workers hold stock options, according to Profs. Douglas Kruse and Joseph Blasi of Rutgers University and Richard Freeman of Harvard University. At some companies, such as Cisco Systems Inc. and Starbucks Corp., virtually all permanent employees are eligible for them.
It isn't just higher share prices that are driving employees to cash in. In an effort to motivate their work forces, many companies stepped up their issuance of employee stock options in the mid-1990s. Now, many of these options are approaching their 10-year Expiration date. In addition, some employees -- burned by the stock market crash in 2000 -- are now choosing to take some of the money off the table early rather than holding out to see if the stock climbs higher. That's also a way for people to diversify assets and keep from having too much tied up in their own company's stock.
While the precise number of options being exercised is unclear, brokerage firms are seeing a major uptick in activity. At Merrill Lynch & Co., which administers some 390 corporate stock-option plans, the number of stock-option exercises quintupled in January from January 2003. The average amount of money collected by employees exercising options also climbed 50%. Merrill Lynch has been getting so many calls from employees with questions about their stock options that it recently hired 18 more people to work in its call center.
UBS AG, meanwhile, says the number of option trades it handled doubled from March to December 2003 -- and then doubled again in a single month: January of this year. During the March to January period, UBS says the value of the roughly 100 options plans it administers more than tripled.
Stock options give workers the right to buy a set number of shares at a preset price at some point in the future. The exercise price is typically the price of the stock at the time the options are issued. If the stock price climbs above the preset price, the gains can be substantial. But if the price drops below the exercise price, the options have no current value. Options typically must be exercised within 10 years, with a portion of the grant Vesting -- becoming exercisable -- each year over a three- to five-year period.
Another shift from the past: Most employees are shying away from using borrowed money to cover the costs of exercising their stock options. That practice got many employees and executives in trouble when the bull market collapsed and share prices fell. Some investors ended up owing far more in loans and taxes than their exercised options were worth.
Some companies have seen the increase in value of their stock options increase drastically. At Cisco Systems, for instance, the value of In the money stock options -- where the exercise price of the options is less than the current market price of the shares -- climbed to $5.5 billion in October, up from $1.4 billion in July 2002. At Amazon.com Inc., the value of in-the-money stock options climbed to more than $1 billion at the end of December from $293 million a year earlier.
At UBS, the portion of stock options in the money climbed to 65% in December from one-third in January 2003. Charles Schwab Corp. says 37% of the options in the plans it oversees were in the money in December, up from 26% a year earlier.
Still, the proceeds from options being cashed in are just one-third of what they were in 1999, UBS calculates. And in anticipation of changes in accounting rules that would force companies to treat stock options as expenses on their income statements, many companies are cutting back on the size of their grants and the number of workers who receive them.
The gains also aren't universal. Many of the options granted by technology companies in 1997 to 2000 remain under water. However, many options granted in 2001 and 2002, when stocks were in the dumps, are well in the money.
The dilemma for employees is whether to cash in now or bet that share prices will rise further. During the bull market, many workers fell into one of two groups. The first group exercised as soon as their shares were vested and typically reaped modest gains. The second group, which often included executives and others with large grants, waited until the options were within a year or less of expiring to cash in.
These days, many advisers suggest that workers take a more measured approach. Among the factors to consider are how much the share price has run up and the chances its value will increase further, how you plan to use the proceeds and how much of your net worth is tied up in your company's shares. For example, if you need options profits to pay for college, you ought to cash in sooner. Likewise, if you have little wealth outside of the options, it's only prudent to take some of the money off the table and diversify.
Robert Barbetti, a senior manager with J.P. Morgan Chase & Co.'s private bank, says he typically advises clients to begin looking at exercising their options in the fifth or six year after the grant was made and begin exercising by year six or seven. "The closer you get to the expiration, the less worthwhile it is to hold on to the option," he says, because of the chances that the stock price could drop. In that case, there may not be enough time for the share price to recover before the option expires.
Another strategy: Set up a plan for regularly exercising options to protect yourself from market declines. Bruce Brumberg of suggests exercising "a certain percentage each quarter and a higher percentage if the stock hits certain price targets."
Things to consider before exercising:
-- In general, think about exercising at least some of your options in the
sixth or seventh year of a 10-year grant.
-- If you hold lots of company stock, you want to exercise some options
earlier to diversify your portfolio.
-- Consider exercising options at regular intervals to protect yourself
from a stock crash.
Should You Exercise Them
Some of the Web sites that provide information and tools on stock options
COST -- Free
COMMENTS -- Information on how stock options work and related tax issues;
message board where questions on stock options and other forms of equity
compensation are answered
COST -- Free to use; $19.95 a year to store data
COMMENTS -- Helps workers determine when to exercise stock options by taking
into account how much money they need to meet key life goals. Will close at
the end of February because of lack of paid subscribers.
COST -- Basic service is free; $99 a year for premium service, which includes
more information and tools*
*Premium service is available free of charge through some employers and
COMMENTS -- Helpful articles on options strategies. Includes calculators to
figure after-tax gains from exercising stock options. Also allows investors
to compare potential returns from holding onto options or exercising them.
COST -- Free
COMMENTS -- Has tool that compares the value of exercising today to waiting
until later. Uses mathematical model to indicate whether it makes sense to
exercise or wait.
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
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