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I have a series of annual employee stock option grants that were struck at varying prices over the course of several years, all of which have now vested. Some options are at this point worth a decent amount, some less so, and some are underwater. My goal is to rebalance my portfolio so that my investments are not so concentrated in my company's stock, so I wish to exercise and sell some options, and reinvest the proceeds in index funds. My question is, what should I consider when picking which of the grants to exercise and sell?

It seems to me there are two factors to consider, which are the expiration date of the grant as well as the outlook for the stock price. It may make sense to exercise the oldest grants first, since I could be forced to exercise at a less advantageous time if I still have them when the expiration date arrives in a few years. I'm also considering the future outlook for the stock - it seems if I expect the stock to continue to go up, I'd be best off exercising the grants with the lowest strike price, since the higher strike price options will see a larger percentage gain in value with each dollar of gain in stock price. On the other hand, if I expect the stock price to go down, I should exercise the grants with the highest strike price, since those are at higher risk of becoming worthless.

As a worked example, suppose I have an option grant struck at $100, another option grant struck at $110, and the current price is $120. I could exercise and sell 1 option of the $100 grant to cash out $20 to invest elsewhere, or 2 options of the $110 grant to achieve the same. If the stock price drops to $110, I'd have been better served by keeping the $100 grant, as I could still get $10 instead of $0. On the other hand, if the stock price rises to $130, I'd have been better off keeping the $110 grant, as I could get $40 for those two options instead of $30 from the single $100 option.

I'm trying to exercise at an advantageous time when the price seems high compared to its recent history, which seems to suggest that I don't have high confidence that the stock will continue to go up much. But at the same time, I'm doing this as a portfolio rebalancing without trying to get too into timing the market. Are there any other things to consider here?

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  • Can you sell the options instead of exercising them? Or at least short offsetting options? Selling the option is almost always more profitable than exercising and selling the satock.
    – D Stanley
    Commented Nov 3, 2022 at 20:14
  • @DStanley Not as far as I know, on my brokerage site I only see options to exercise and sell, hold, or sell-to-cover. Not sure if there's some other way to do it. Commented Nov 3, 2022 at 20:26

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I don't have much data or calculations to back this up, but if I were you, I would

  1. Decide how much (dollars or shares) I want to exercise
  2. Exercise the oldest options until I have exercised as many as I decided in step 1 (probably rounding up or down to the nearest whole lot if it's anywhere close, just for simplicity)

If you just want to exercise to and sell, go ahead and sell all the shares.

If you want to sell some but not all of the shares: 3. Sell the shares with the highest cost basis. This is for two reasons. One, to minimize the income taxes this year (and defer as much income tax as possible). Two, because there are some negative (or at least non-intuitive) tax effects when you have non-qualified stock option exercises that sell for a price lower than the strike price.

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  • I'm interested in reallocating a dollar amount, rather than a specific number of options. I don't want to exercise-and-hold any of the options, as that just gets me further invested in a single stock, when I'm trying to accomplish the opposite. Minimizing the tax amount seems like it can only be accomplished by minimizing the profit from exercising and selling, but again, I have a dollar value target I want to move from options to index funds. Commented Nov 9, 2022 at 16:09
  • Is there any tax benefit to exercising and selling 100 options that are $10 above the strike price, versus exercising and selling 50 options that are $20 above the strike price? The short-term gain is $1000 either way. I don't follow your comment about the negative tax effects - I'd think that exercising, holding, and later selling for less than the exercise price should result in a tax-beneficial capital loss. Commented Nov 9, 2022 at 16:10
  • If you plan on exercising and selling all immediately, point 3's not really relevant.
    – stannius
    Commented Nov 16, 2022 at 4:01
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    If you did exercise and hold, tax treatment would depend on whether the shares ended qualified or not by the time you sold. I'd have to look it up, but for nonqualified shares, it's something like the diff between fair market value and strike price is ordinary income, and then the drop between FMV on purchase date and the sale price is a capital loss (which first offsets capital gains and then only $3k of ordinary income).
    – stannius
    Commented Nov 16, 2022 at 4:02
  • I wouldn't agree that a capital loss is necessarily beneficial. You are forced to use it to offset capital gains, which may have been taxed at a favorable rate. And then you can only use $3k of leftovers to offset ordinary income. I would definitely not want to pay ordinary income on the gain between FMV and strike, and then in exchange get a less favorable capital loss.
    – stannius
    Commented Nov 16, 2022 at 4:06

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