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Your paycheck may not come completely in cash. Many firms offer the ability to use shares from the company to increase your net worth. One of these potential choices is stock options, which allow you to purchase shares at a later date at a fixed price. The fixed price is known as the strike price.

Stock options should be used when their market price is higher in value than the option’s strike price. Converting stock options into shares when the market price is above the strike price will result in an instant net worth increase, assuming you instantly sell the shares. Note: taxes on shares sold within a year of stock option exercise will be taxed as income tax and not capital gains. Holding shares may result in a price decrease and a loss. Since you are still purchasing the shares, a decrease in price cancels your profit or loses money. The further the shares increase in value, the more is gained from the conversion. If the share price is the same as the strike price, or below the strike price, there is no gain in net worth.

Limitations

There are boundaries on your options. They almost always have an expiration date, usually between five and ten years. They have other conditions as well. Typically, to actually use a company’s share options you must currently work for the business. If you have been discharged or resigned your ability to exercise any stock option will be revoked.

Concerns & Company Performance

Stock options are not always appropriate simply based on the market price being higher than the strike price. Your usage of share options will also be determined by the financial status of the firm, or your personal situation. These rules will modify your approach. The company’s situation is rather straightforward: the company must perform well as an investment. Since you’re buying the shares via options you must analyze and evaluate the company just like any other investment. Do not simply assume your employer is fit for investment.

Concerns: Diversification

Your existing investments should be factored in as well. If you hold a large percentage of company stock in your portfolio (anywhere in the double digits) you should think carefully before acquiring more. Your investment within the firm will be over-concentrated. If the firm tailspins, you’re overly exposed to financial loss. If you’re absolutely set on using options, consider selling previous shares, then using your options to acquire more.

The same issues apply to your employer’s industry. Industry centered economic shocks do occur. Holding a lot of investments in the same industry as your employer can result in a financial wipeout.

Concerns: Personal Finances

Your personal financial situation also applies. If you have debts, financial concerns or problems, they should be resolved before you purchase shares via options. The last thing you can afford is purchasing the shares with money you barely have, especially if the company eventually fails financially. Many investment illiterate workers purchase shares in their companies, only to watch their firm tailspin. They lose net worth while having debts and other financial issues.

If you’re clear of problems on all three fronts, you can consider using your options. There are quite a few strategies to consider. These strategies change with your preference in holding the shares. If you’re purchasing to sell the stock, keep in mind that you should wait to sell the equity. If you buy and sell shares within a calendar year, your sale gets calculated as cash income and not capital gains. This changes your tax rate from the capital gains tax rate to your income bracket tax rate. Income tax rates are almost always higher than capital gains tax rates.

If you’re a value investor and you plan to hold the shares long term, the strike price should be equal to or below the discounted intrinsic value of the shares. In both cases, purchase shares when the strike price is below market price. If the prices begin to fall, you have more room to sell the shares before you suffer an actual loss.

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