Is it better to exercise options or purchase stock at the same price?
January 18, 2006
Subject: Non qualified stock options
Date: Thu, 01 Dec 2005
I have 1,000 shares of non-qualified stock options at an option price of $18 and the fair market value of the shares is also $18. I expect the stock to increase in value to $30. My advisor is telling me that it’s better to exercise the options in this case rather than buying the shares on the open market. What’s the difference?
Date: Fri, 09 Dec 2005
If you have a choice, it’s better to buy the shares on the open market and not exercise the options. The value of the options is having a right to exercise them at a constant price when the market value increases, without having to risk a cash outlay. Of course you will have ordinary income if the stock value increases. Why lose a valuable right when you can get the same benefit while keeping the right?
An exception is when you don’t have a choice or you are in front of a hyper-increase. For example, Google employees were able to get most of their shares before the company went public by exercising employee stock options. If that’s the only way you can get the shares and you expect a huge increase in value like that, it’s best to exercise the options earlier. Just remember that Google was an exception and the value of most new issues goes down after the employee lock-out period expires.