What to pick: RSU or stock options?

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learning_head
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What to pick: RSU or stock options?

Post by learning_head »

Hi folks, would love some help with a choice that Mega-Corp is offering, i.e. a choice of RSUs or options:
- take 1 RSU, or
- take 4 stock options (NQ)
- (could also split some RSUs / some stock options in whatever proportion I want but based on same 1-to-4 ratio as above)

Both vest over 4 years (1/4 each year). Stock options expire after 10 years.

Some other info / observations - maybe not all are material to the choice I have to make... :
- with 1-to-4 ratio, stock would need to be 33% higher at the time of sale to make option more valuable, but option gets its (time-)value after vesting (and until 10 when it expires), while RSUs no longer have additional value after they vest
- stock is near multi-year highs, so stock option strike price seems high at the moment (noone knows over 10 years of course, but just saying); stock market is of course at all-year highs
- I currently hold a bunch of stock options from past years (RSUs are a new choice)
- I also happen to have the company stock that I had accumulated a while ago and have not sold all of it yet (in the process of selling over years)
- My overall exposure to company stock and options is ~8% of my NW
- I understand that there is got to be some ratio at which RSUs are clearly better (e.g. 1-to-1) and some ratio at which stock options are clearly better (e.g. 1-to-100). So, I guess at some ratio they are about the same - wonder that that ratio would be.

Appreciate your thoughts!

P.S. Irrelevant points that sometimes detract me from thinking more clearly: Historically, I've been able to cash out stock option at about twice what RSUs would give me today if they stayed at same price with the offered 1-to-4 ratio. In other words, for every stock option, I was able to get ~$40 in the past and today's price of stock is around $80, so 4 * $40 = $160 for 4 stock options vs I would get $80 for 1 RSU if stock did not move for 4 years on average. Of course with everything at multi-year highs, chances are going forward I may not be able to realize the $40 per stock option historical average. On the other hand, RSUs seem like a gamble of what the price will happen to be on exact 4 yearly anniversaries of the grant - no guarantees there either.
Last edited by learning_head on Sat Jun 14, 2014 12:18 pm, edited 1 time in total.
MN Finance
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Re: What to pick: RSU or stock options?

Post by MN Finance »

I don't know the ratio, but I wonder if 4 to 1 is the break even. If it is, then it must be neutral for the company. If it's neutral cost for them, does that mean neutral benefit for you? No idea, just not sure how to think through it.

Clearly there's more risk reward in options, so some of it might be your appetite to take the risk.
dbr
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Re: What to pick: RSU or stock options?

Post by dbr »

MN Finance wrote:I don't know the ratio, but I wonder if 4 to 1 is the break even. If it is, then it must be neutral for the company. If it's neutral cost for them, does that mean neutral benefit for you? No idea, just not sure how to think through it.

Clearly there's more risk reward in options, so some of it might be your appetite to take the risk.
I don't have an analysis of the expected value of one vs. the other, but on the principle of taking least risk it would seem that the RSUs liquidated as quickly as allowed would be the best choice. Individual stock holding and company stock holding is something one probably wants to get rid of as soon as possible. Stock options are a different animal and do offer an opportunity for greater gain or no benefit at all. It really is apples to oranges for you even if the prospect is cost neutral for them.
Radnog
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Re: What to pick: RSU or stock options?

Post by Radnog »

You probably can't go wrong with either, but I would likely favor the RSUs because they can't ever be "under water".
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mhc
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Re: What to pick: RSU or stock options?

Post by mhc »

The options take longer to realize the full value. How long are you going to stay with the company? Options can take 8-10 years to convert the intrinsic value to extrinsic value. RSU's are what they are after 4 years.

You could play with an options calculator to see if the 4:1 ratio is equitable.

I would probably go with the RSU's because of the shorter duration and never go underwater.
dbr
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Re: What to pick: RSU or stock options?

Post by dbr »

mhc wrote:The options take longer to realize the full value. How long are you going to stay with the company? Options can take 8-10 years to convert the intrinsic value to extrinsic value. RSU's are what they are after 4 years.

At Megacorp you have 24 hours from termination to exercise or lose your ISO's. If you retire you retain your options to expiration. It would be good to understand the rules.

You could play with an options calculator to see if the 4:1 ratio is equitable.

I would probably go with the RSU's because of the shorter duration and never go underwater.
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mhc
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Re: What to pick: RSU or stock options?

Post by mhc »

dbr wrote:
mhc wrote:The options take longer to realize the full value. How long are you going to stay with the company? Options can take 8-10 years to convert the intrinsic value to extrinsic value. RSU's are what they are after 4 years.

At Megacorp you have 24 hours from termination to exercise or lose your ISO's. If you retire you retain your options to expiration. It would be good to understand the rules.

You could play with an options calculator to see if the 4:1 ratio is equitable.

I would probably go with the RSU's because of the shorter duration and never go underwater.
I looked again, but I don't see where it says ISO's. I assumed NQSO's. At my mega-corps that I have worked for, they give 30-90 days after termination due to layoffs to exercise vested NQSO's. I have never received ISO's, so I am not familiar with the rules/customs associated with them.
dbr
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Re: What to pick: RSU or stock options?

Post by dbr »

mhc wrote:
dbr wrote:
mhc wrote:The options take longer to realize the full value. How long are you going to stay with the company? Options can take 8-10 years to convert the intrinsic value to extrinsic value. RSU's are what they are after 4 years.

At Megacorp you have 24 hours from termination to exercise or lose your ISO's. If you retire you retain your options to expiration. It would be good to understand the rules.

You could play with an options calculator to see if the 4:1 ratio is equitable.

I would probably go with the RSU's because of the shorter duration and never go underwater.
I looked again, but I don't see where it says ISO's. I assumed NQSO's. At my mega-corps that I have worked for, they give 30-90 days after termination due to layoffs to exercise vested NQSO's. I have never received ISO's, so I am not familiar with the rules/customs associated with them.
I am just pointing out that you were on point to bring up the issue of longevity in the company. It adds to the incentive to choose the RSU. My example was an extreme one for illustration.
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learning_head
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Re: What to pick: RSU or stock options?

Post by learning_head »

Yes, these are NQSOs (I edited OP to mention this too). I think I have 3 months after leaving company to exercise these though don't recall for sure. I will probably stay with the company for a while but yes, good to consider what happens if I don't.

Thanks
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learning_head
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Re: What to pick: RSU or stock options?

Post by learning_head »

mhc wrote:You could play with an options calculator to see if the 4:1 ratio is equitable.
Any suggestions on how to do this? I am not exactly following here.
MN Finance
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Re: What to pick: RSU or stock options?

Post by MN Finance »

I don't think you can calculate it with a calculator since the upside of the options is entirely driven by upside in the stock. You have to assume a discount rate for the stock, then compare the value im X years of each choice. By just adjusting the rate a very small amount it completely changes the outcome. Or you solve for the breakeven discount rate. Then if you believe the stock will return more/less you either choose the stock or the option. Then layer on that you risk appetite.
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Re: What to pick: RSU or stock options?

Post by Grt2bOutdoors »

Stock Option = Lottery Ticket
Restricted Stock Units = Bird in Hand, assuming you remain employed during the vesting period.

As Clint Eastwood says "How lucky do you feel"?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Longtimelurker
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Re: What to pick: RSU or stock options?

Post by Longtimelurker »

I don't know if this helps, but here is how I view RSU's and Stock Options when I get them.

- RSU's are viewed as a "deferred cash flow pipe" which i discount at 50% for NW purposes until they vest, then I sell immediately and re-allocate those funds into my standard portfolio.
- Stock Options are viewed as "home run swing" which i discount at 100% for NW purposes and hold for maximum duration. Their leveraged nature makes them attractive with a 10 year horizon.

So, if I had the option I would determine which I wanted more at the time of the decision, a "deferred cash flow pipe" or a "home run swing." Likely no wrong answer here.
Stay the course. If you can't resist greed, and fear is proven to be 2x as strong, you are doomed as an investor.
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mhc
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Re: What to pick: RSU or stock options?

Post by mhc »

learning_head wrote:
mhc wrote:You could play with an options calculator to see if the 4:1 ratio is equitable.
Any suggestions on how to do this? I am not exactly following here.
RSU's, NQSO's, ISO's are to some degree just options. A common method for pricing options is to use the Black Scholes (sp?) method. If you google it, you can see that there are some calculators available. Your company is using some formula for valuing the options because they have to expense them. I spent one evening a few months ago reading and playing with calculators. After a few hours I was able to figure out how to value options that my company grants. Fortunately, my company lists the current value of the options when they grant them. This way I can play with the variables that go into pricing the options until I get a good match.

The calculators can also give you a feel for intrinsic value vs. extrinsic value.
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Re: What to pick: RSU or stock options?

Post by mhc »

MN Finance wrote:I don't think you can calculate it with a calculator since the upside of the options is entirely driven by upside in the stock. You have to assume a discount rate for the stock, then compare the value im X years of each choice. By just adjusting the rate a very small amount it completely changes the outcome. Or you solve for the breakeven discount rate. Then if you believe the stock will return more/less you either choose the stock or the option. Then layer on that you risk appetite.
Why not? People price options every day. Your company has to place a value on the options so that they can account for them appropriately. People trade options.
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Re: What to pick: RSU or stock options?

Post by mhc »

dbr wrote:
I am just pointing out that you were on point to bring up the issue of longevity in the company. It adds to the incentive to choose the RSU. My example was an extreme one for illustration.
Sorry if my response to you did not come across well.
madbrain
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Re: What to pick: RSU or stock options?

Post by madbrain »

I received an award on the same day as you did, also at a Megacorp. But I don't think it's the same one based on the stock price you mention.

I can either choose X stock options, or X/4 RSUs, or X/2 stock options + X/8 RSUs . Those are the only 3 choices. Vesting is over 4 years either way.

I also have company stock options, which are well in the money (exercise price only 60% of current FMV) and have about 14 more months of vesting left. I have been selling those as they vest, and plan on continuing to do so. I participate in ESPP but always sell the stock immediately to capture the meager 5% discount. I don't hold the company stock long term.

One problem with making the decision is that the exercise price for options is not known. After the choice is made, the board will approve the grant, and it will be effective in about 60 days.
That means the exercise price could be higher - or lower.

The stock price is not yet at its all time high, but close, and the peak was a long time ago, during the dot com days. This makes me wary of choosing the options.
If I chose RSUs, I would probably sell them as soon as they vest.
If I chose options, I probably would sell as soon as they vest if they have meaningful value; I would not likely be holding them the full 10 years (expiration schedule).

Assuming a sale on the day of vesting for either NQSOs or RSUs, I calculated that the NQSO only come out ahead if the annual growth rate of the stock price is 11.85% or higher.
This seems highly unlikely for most tech Megacorps, given current valuations.

Obviously, if I planned on holding the stock longer as opposed to doing same-day sales, that may change the expected results. But as it is, the choice seems clearly in favor of RSUs.

Here are my calculations assuming initial stock price of $100, 1000 NQSO (or 250 RSU), and the results over 4 years assuming different stock price growth rates.
I don't really expect more than 6% annual stock price growth.

Image
Tanelorn
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Re: What to pick: RSU or stock options?

Post by Tanelorn »

Does the stock pay dividends? Sometimes RSU's get dividends and it's rare for options to do so, and that could matter over 10 years for the options.
MN Finance wrote:...the upside of the options is entirely driven by upside in the stock.
No, the stock price matters but so does the market's view on future volatility of the stock price. Market-wide, volatility is at nearly an all time low - this means that it's possible if volatility picks up that options could become more valuable even if the stock price falls some.
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Re: What to pick: RSU or stock options?

Post by madbrain »

Tane,
Tanelorn wrote:Does the stock pay dividends? Sometimes RSU's get dividends and it's rare for options to do so, and that could matter over 10 years for the options.
In my case, yes the company pays a dividend. RSUs would get dividends after vesting.
NQSO would get dividends after exercise.

I am not counting the dividends because I would sell the RSUs or NQSOs upon vesting.
MN Finance wrote:...the upside of the options is entirely driven by upside in the stock.
No, the stock price matters but so does the market's view on future volatility of the stock price. Market-wide, volatility is at nearly an all time low - this means that it's possible if volatility picks up that options could become more valuable even if the stock price falls some.
You cannot trade employee stock options NQSO on the open market, so the volatility is irrelevant. If the exercise price is above the current fair market value of the stock, then the NQSO is worthless, regardless of volatility.
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Re: What to pick: RSU or stock options?

Post by Tanelorn »

madbrain wrote:You cannot trade employee stock options NQSO on the open market, so the volatility is irrelevant. If the exercise price is above the current fair market value of the stock, then the NQSO is worthless, regardless of volatility.
I'm not an expert on NQSO's but in general early exercise is suboptimal for American options, so I would think the economically best thing would be to wait right until the option expired to exercise (or not, if unlucky). Until expiration, options do very much have value from volatility even if they aren't traded for you to see it. A $50 option on a $49 stock has a lot of potential if it's got a few years to go, and moreso if the stock is volatile. It can't be worth less than zero, and it might be worth a lot. Do you see what I mean?

I understand you might be strongly in favor of exercising and selling immediately upon vesting for AA reasons, but it seems like it would at least be worth estimating how much time value you were throwing away by doing this by running the NQSO values through a Black-Sholes calculator like this one:

http://www.mystockoptions.com/black-scholes.cfm

There are complicated ways to realize the time value of the option without selling it, but those aren't practical for most people and require you to be allowed to short your company stock among other things.
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Re: What to pick: RSU or stock options?

Post by Bfwolf »

I think this is a no-brainer for the RSUs. My company was offering similar 4 to 1 ratio, but the options vested 34/33/33 over 3 years while the RSUs vested 0/0/100 so it was even more in favor of options than your choice (although the options only lasted 7 years vs your 10). Something like 80% of the people in the company took the RSU choice. I think the company wanted more options vs RSUs because they increased the ratio to 5 to 1 but I don't think it changed much.

The RSUs have 2 key advantages over the options:

1) You already have significant exposure to your company stock. With more options, you will have even more exposure compared to the RSUs.

2) You won't get the company dividends with the options so you're not going to get the full increase in value of the company over the potential 10 years of ownership. With the RSUs, once they vest and you sell them, you'll get the full increase in value of your regular asset allocation.

IMO, unless the ratio got to 6 to 1, I wouldn't even consider the options.
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Re: What to pick: RSU or stock options?

Post by madbrain »

Talelorn,
Tanelorn wrote:
madbrain wrote:You cannot trade employee stock options NQSO on the open market, so the volatility is irrelevant. If the exercise price is above the current fair market value of the stock, then the NQSO is worthless, regardless of volatility.
I'm not an expert on NQSO's but in general early exercise is suboptimal for American options, so I would think the economically best thing would be to wait right until the option expired to exercise (or not, if unlucky). Until expiration, options do very much have value from volatility even if they aren't traded for you to see it. A $50 option on a $49 stock has a lot of potential if it's got a few years to go, and moreso if the stock is volatile. It can't be worth less than zero, and it might be worth a lot. Do you see what I mean?
Yes, I know such an underwater option might have a lot of value *in the future*.
But since you can't trade your NQSO option as an employee, there is nothing you can do to realize that value immediately.
You cannot sell your NQSO option to anyone else.
I understand you might be strongly in favor of exercising and selling immediately upon vesting for AA reasons, but it seems like it would at least be worth estimating how much time value you were throwing away by doing this by running the NQSO values through a Black-Sholes calculator like this one:

http://www.mystockoptions.com/black-scholes.cfm
Yes, i am familiar with Black scholes option pricing.
But this model does not take into account the fact that the option doesn't just have a fixed 10 year expiration; it also has a potential much earlier expiration if you leave the company, and that date is unknown.
Not many people stay the full 10 years after being granted an option. Many will leave before, whether voluntarily or not. You can't easily plug that into Black Scholes.
Ultimately, with NQSO, only the intrinsic value is relevant, ie. difference between FMV and exercise price. Any potential "time value" is forfeited with NQSO. So I don't see the relevance of Black Scholes with NQSO.
There are complicated ways to realize the time value of the option without selling it, but those aren't practical for most people and require you to be allowed to short your company stock among other things.
Yes. Most employers have insider trading policies that prevent employees from shorting the company stock, as well as trading derivatives on company stock. This is the case for my company.
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Re: What to pick: RSU or stock options?

Post by random_walker_77 »

Longtimelurker wrote:I don't know if this helps, but here is how I view RSU's and Stock Options when I get them.

- RSU's are viewed as a "deferred cash flow pipe" which i discount at 50% for NW purposes until they vest, then I sell immediately and re-allocate those funds into my standard portfolio.
- Stock Options are viewed as "home run swing" which i discount at 100% for NW purposes and hold for maximum duration. Their leveraged nature makes them attractive with a 10 year horizon.

So, if I had the option I would determine which I wanted more at the time of the decision, a "deferred cash flow pipe" or a "home run swing." Likely no wrong answer here.
I second Longtimelurker's view. Keep in mind that RSU's are pretty much guaranteed to have value when they vest. Options could be worthless. Their great value is that they magnify the upside (b/c you usually get many more of them), and the 10 yr length works in your favor, so long as you stay w/ the company. You need to derate their value not only for the possibility that the stock price doesn't go up (33% in your case), but also for the possibility that you might leave the company early, either because you find another job and leave on your terms, or because you're asked to leave. I think that one of the biggest problems is that you'll lose the option if you're laid off, and if there's a recession, options-holders face the potential double-whammy of depressed stock prices and a forced exit at a time when the option is most likely to be worthless.

Sometimes, it almost seems better to get options in the depths of a recession (assuming you have the leverage to get options when many are happy to just get/keep a job). And options after a major stock run might face more headwinds from the normal market cycle.
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Re: What to pick: RSU or stock options?

Post by Tanelorn »

madbrain wrote:Yes, I know such an underwater option might have a lot of value *in the future*.
But since you can't trade your NQSO option as an employee, there is nothing you can do to realize that value immediately.
Right, all you can do is hold it to get the time value in expectation.
Yes, i am familiar with Black scholes option pricing.
But this model does not take into account the fact that the option doesn't just have a fixed 10 year expiration; it also has a potential much earlier expiration if you leave the company, and that date is unknown.
Not many people stay the full 10 years after being granted an option. Many will leave before, whether voluntarily or not. You can't easily plug that into Black Scholes.
So plug in each year from 1 to 10 and see how it looks. At a very crude first pass, figure the delta of the option is equal to that fraction of a share. If it's got delta >0.25, maybe 4 options is better than 1 RSU and then think a bit harder about the options... You can probably put rough guesses on how long you would like to work at the same company, together with how many people got laid off in the last recession to judge your chances of being forced out early. I'm not saying it's easy, but it's probably a lot easier than estimating tax rates in retirement 30+ years from now and people do that all the time in their financial planning.
Ultimately, with NQSO, only the intrinsic value is relevant, ie. difference between FMV and exercise price. Any potential "time value" is forfeited with NQSO. So I don't see the relevance of Black Scholes with NQSO.
I still think the time value is relevant for the period between grant and exercise. Yes, intrinsic value is all that matters when you exercise, but that doesn't happen for years if only due to vesting periods if nothing else.
Most employers have insider trading policies that prevent employees from shorting the company stock, as well as trading derivatives on company stock. This is the case for my company.
You sound like you hold no company stock longer than necessary, but that isn't true for many people, even people here. If you would otherwise be holding some company stock, selling down that desired position is equivalent to shorting relative to your target AA.
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Re: What to pick: RSU or stock options?

Post by madbrain »

Tanelorn wrote: You sound like you hold no company stock longer than necessary, but that isn't true for many people, even people here. If you would otherwise be holding some company stock, selling down that desired position is equivalent to shorting relative to your target AA.
I feel that I am already sufficiently exposed to my employer's stock through indexes, as it is a Megacorp. I don't really feel the need for more than that.
Due to its large size, I don't feel that it has better than average appreciation potential. But I have been wrong before :)

If I was working for a small startup, obviously, I might not want to sell the stock early on. RSUs probably wouldn't be a choice though, for companies that are not publicly traded.
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Re: What to pick: RSU or stock options?

Post by Wagnerjb »

Tanelorn wrote:
madbrain wrote:You cannot trade employee stock options NQSO on the open market, so the volatility is irrelevant. If the exercise price is above the current fair market value of the stock, then the NQSO is worthless, regardless of volatility.
I'm not an expert on NQSO's but in general early exercise is suboptimal for American options, so I would think the economically best thing would be to wait right until the option expired to exercise (or not, if unlucky). Until expiration, options do very much have value from volatility even if they aren't traded for you to see it. A $50 option on a $49 stock has a lot of potential if it's got a few years to go, and moreso if the stock is volatile. It can't be worth less than zero, and it might be worth a lot. Do you see what I mean?

I understand you might be strongly in favor of exercising and selling immediately upon vesting for AA reasons, but it seems like it would at least be worth estimating how much time value you were throwing away by doing this by running the NQSO values through a Black-Sholes calculator like this one:

http://www.mystockoptions.com/black-scholes.cfm

There are complicated ways to realize the time value of the option without selling it, but those aren't practical for most people and require you to be allowed to short your company stock among other things.
I agree with Tanelorn. The most financially logical strategy is to hold stock options until close to expiration. If an individual feels compelled to exercise immediately after vesting, then a different strategy may make sense for them. But in that case one is valuing psychological issues over financial ones. It is important to acknowledge this so that others here can make the best decision for themselves.

Best wishes.
Andy
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Re: What to pick: RSU or stock options?

Post by Wagnerjb »

If you feel comfortable managing your income taxes, I would choose the RSU's one year, then choose the stock options in the following year. With alternate year selection, you can maximize your tax management opportunities. Here is how:

If you elect to receive RSU's every year, your income will be relatively stable in the future. You will have salary plus the vesting of the RSU's. Let's say that amounts to 100 each year.

If you elect to receive options, you can choose when to exercise them (and you pay tax when you exercise them). If you "bunch" the exercise into alternate years, you might have income of 70 in one year, and 130 in the next year. This would allow you to have a low income year and capture some tax benefits (eligible for Roth, pay zero tax on capital gains, avoid AMT, stuff like that). In the high income year, you bunch your charitable contributions and property tax payments.

My initial thoughts were to recommend half and half each year, but the strategy I laid out above achieves the same balance but also allows for maximum tax management. I prefer the 50/50 mix so that you don't ever have the worst outcome. If your stock drops by 30%, your options are worthless but you still have some value in the RSUs. If your stock surges, the RSU's aren't worth nearly as much as options....but you have some options as well.

I was granted stock options (NQ) for many years, and for the past 10 years I have received RSU's. I much prefer the stock options, but maybe my experience is colored by the fact that they paid off nicely. :D

Best wishes.
Andy
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Re: What to pick: RSU or stock options?

Post by madbrain »

Wagnerjb wrote: I agree with Tanelorn. The most financially logical strategy is to hold stock options until close to expiration.
Which is great if you are able to, but since the expiration can really expire anytime upon termination, I find that advice to be hard to follow.
If an individual feels compelled to exercise immediately after vesting, then a different strategy may make sense for them. But in that case one is valuing psychological issues over financial ones. It is important to acknowledge this so that others here can make the best decision for themselves.
I have been involuntarily terminated twice before, and it resulted in forfeiting of some stock options each time.
So, I don't think there is any "psychological issue" here, merely awareness of reality.
If the stock options truly had a 10-year expiration, I would be more apt to consider holding them for a longer term.
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Re: What to pick: RSU or stock options?

Post by madbrain »

Tanelorn wrote: So plug in each year from 1 to 10 and see how it looks. At a very crude first pass, figure the delta of the option is equal to that fraction of a share. If it's got delta >0.25, maybe 4 options is better than 1 RSU and then think a bit harder about the options... You can probably put rough guesses on how long you would like to work at the same company, together with how many people got laid off in the last recession to judge your chances of being forced out early. I'm not saying it's easy, but it's probably a lot easier than estimating tax rates in retirement 30+ years from now and people do that all the time in their financial planning.
Sure, I can try to estimate years 1 to 10.
I don't think I need to calculate the "delta", all I can do is look at different stock price predictions and look at the predicted intrinsic value I will realize at exercise time.
But there are a lot of variables.

As far as working at the same company, even though I'm willing to stay the 10 years, some decisions just aren't in your control. When certain product lines get axed, more often than not, the entire groups responsible for them get laid off. It's more about being in the right place at the right time. At least that's what I have seen. So, I'm not going to try to predict that.

Other variables are tax rates. In the previous simulation, I didn't account for taxes because they would be the same assuming sale at vesting date for both RSU and NQSO.
But if that assumption of sale on vesting date is not true, there are a lot of possible scenarios for what to do with the RSUs.

One is to hold the RSUs the full 10 years, but I think that makes no sense, especially since tax is due upon vesting for RSUs, even if they are not sold.
Another is to sell the RSUs upon vesting as I proposed already, and then reinvest proceeds into something else - I would likely choose an equity index, S&P500 or Total stock market.
In this case, taxes would be due upon selling the RSUs vesting, then tax again upon sale depending on capital gain. So, the second variable is the tax rate.
Then, I would have to estimate the growth rate of the index fund which would be held until year 10. The growth rate would be the 3rd variable.
At the end of the 10 years, I would end up with an amount in the fund with a basis, and an unrealized capital gain or loss. I would probably hold that fund past 10 years, though.

There are also many possible choices with the NQSO. One is to exercise upon vesting. I likely wouldn't go for that due to the upfront outlay, and taxes due on exercise.
The other extreme is to hold them throughout the whole 10 years, and sell in year 10. Taxes would be due at that point.
For that case, the second variable would be the tax rate due in year 10 - which could be a substantially higher rate due to selling everything in the same calendar tax year.

I will put some more thought into it and see how much that changes the numbers for 10 years for these various cases.
I think I can estimate the tax rate and assuming the same current rate, around 28% federal, 9.3% state, and 1.45% medicare for years 1-9.
Federal tax rate would likely be higher for the NQSO case in year 10.

So the 2 main variables are the growth rate of the employer stock price, and growth rate of index.
The possibility of termination is too much of a wildcard to be able to plug into estimates, IMO.
madbrain
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Re: What to pick: RSU or stock options?

Post by madbrain »

Wagnerjb wrote:If you feel comfortable managing your income taxes, I would choose the RSU's one year, then choose the stock options in the following year. With alternate year selection, you can maximize your tax management opportunities. Here is how:

If you elect to receive RSU's every year, your income will be relatively stable in the future. You will have salary plus the vesting of the RSU's. Let's say that amounts to 100 each year.

If you elect to receive options, you can choose when to exercise them (and you pay tax when you exercise them). If you "bunch" the exercise into alternate years, you might have income of 70 in one year, and 130 in the next year. This would allow you to have a low income year and capture some tax benefits (eligible for Roth, pay zero tax on capital gains, avoid AMT, stuff like that). In the high income year, you bunch your charitable contributions and property tax payments.
I feel comfortable managing my own taxes, and already do.

However, I am already very close at the threshold for Roth contribution eligibility. I can't actually predict if I will be eligible or not this year, it depends on bonus/raise mostly. My guess is I will be over the threshold this year. But in any case, I can do backdoor Roth with no cost since I have no traditional IRA balance.

0% tax on capital gains is impossible as long as I am working since my ordinary income tax rate is already 28%.

AMT - I haven't been a victim yet. Don't know if it's in the cards.

Property tax payment bunching - I have an escrow account required by my lender, so that is not possible.

That leaves the charitable contributions, and I already manage them, but they are not large enough to change my overall tax bracket/situation for any given tax year.
My initial thoughts were to recommend half and half each year, but the strategy I laid out above achieves the same balance but also allows for maximum tax management. I prefer the 50/50 mix so that you don't ever have the worst outcome. If your stock drops by 30%, your options are worthless but you still have some value in the RSUs. If your stock surges, the RSU's aren't worth nearly as much as options....but you have some options as well.
Note that I don't have the choice to get "RSU one year" and "NQSO the next year".
The only choice for splitting between NQSO and RSU is as follows :
- total grant of X/2 NQSO and X/8 RSU
- each year, vest X/8 NQSO and X/32 RSU, over 4 years
Since RSUs will vest each year still, that will generate some additional taxable income for each of the 4 years, whether the RSUs are sold or not (unless the stock becomes worthless, of course).

The only flexibility is when to exercise the NQSO, and when to sell them. With the high California state income tax rate, and no preferential tax treatment for holding stock long-term, you would have a hard time convincing me to do anything other than a same-day sale with NQSO, even if I waited a long time to exercise.
I was granted stock options (NQ) for many years, and for the past 10 years I have received RSU's. I much prefer the stock options, but maybe my experience is colored by the fact that they paid off nicely. :D
Yes, I think our respective experiences changes how we view these instruments. Very few of the NQSO I have been granted in my lifetime have ever turned out to be worth anything, mostly because the company stock prices only went down long term. Just bad luck.
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