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Investors who adhere to financial plans typically experience better investment returns. Financial planning allows for what-if scenarios that provide perspective, and its critical to review this plan with your advisor yearly.

Many investors have vested stock options where the underlying share price has fallen sharply or the stock options are now underwater. The impact of market volatility on their equity compensation has these investors anxious, and it’s taking an emotional as well as a financial toll on them. Is there anything an investor can do to address these concerns?

Financial planning with a stock options exit strategy

In the ideal situation, the investor has already reviewed goals for these options as part of a comprehensive financial plan. A well-designed strategy will set a price point and time frame for exercising each stock option, thereby establishing a disciplined framework for decisionmaking. The plan should incorporate the investor’s risk tolerance, outlooks for the underlying stock and market conditions, current and/or future financial needs (e.g., college, home renovations), any existing concentration of employer stock and income tax ramifications.

Stock options have two valuation components. Time value is derived from the ability to purchase stock at a fixed price for the option’s term, while the intrinsic value is the known value of the current share price less the strike price. When a stock option is granted, its value is composed almost entirely of the time value.

As time passes, the option’s value shifts to the known intrinsic value. A sound strategy takes this into account when price points and time frames are established.

It’s also important that an investor not be too focused on tax consequences that result from exercising options. If any of us receive a cash bonus, we pay the taxes and don’t think twice about it. The way to consider stock options should be the same. And there’s always a risk if the holder of an option becomes too tentative about exercising because of tax concerns: Market volatility can decrease the value of the option to the point that the potential gain from its exercise is significantly decreased or lost.

Hold or sell?

Many investors wonder if they should exercise an option and hold the stock or exercise and sell (cashless exercise). In a down market, the investor should consider if there are reasonable, fundamental reasons — not emotional ones — for believing that the stock will rise, along with assessing their current stock concentration. If their concentration isn’t too high and they believe the stock value will increase, then holding may make sense. However, if the investor doesn’t feel the stock price will rebound or they have too much employer stock, they should exercise and sell. The after-tax proceeds can be redeployed in their diversified portfolio as determined by the financial plan. A diversified portfolio might perform better and with less volatility than the company stock.

Gaining peace of mind with a plan

Investors who adhere to financial plans typically experience better investment returns than those who try to time the market. Financial planning can allow for what-if scenarios that provide perspective on when to exercise if the stock price rises in the future. The plan and stock options should be reviewed and updated once a year to incorporate any new set of grants. As a result, an investor has peace of mind knowing that a comprehensive, holistic financial plan is in place, one that provides for a successful retirement and deals with the big picture.

For more information, please contact your Key Private Bank Advisor.

Publish Date: May 18, 2020.

Any opinions, projections, or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

This material is presented for informational purposes only and should not be construed as individual tax or financial advice.

KeyBank does not give legal advice.

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