Understanding Stock Options: A Brief Look

A reader (whose identity shall remain secret) writes:

I had a question about stock options that I was hoping you could answer. I work for a BIG internet company (you can probably guess which one). I have 114 stock options; a quarter of which vest each year for four years with a 10 year lifespan. The stock price is currently quite high, and I was wondering if you had such options would you cash out at a high stock price or hold on to them for the 10 year period. I don’t “need” the cash for living expenses or debt, but I don’t have very much for travel and other such things.

Let’s “guess” that this person works for Google (GOOG). Google’s stock currently sits at about 508. I’m going to speculate that this person’s option exercise price is rather low, substantially lower than the current price (if it’s close to the price or equal to it, ignore what is being said here and hold it).

The biggest question you need to ask yourself is do you believe that your company is going to continue to grow at a rapid pace? You should have somewhat more insight into this than the average person because you work for the company. Are there good, money making products in the pipeline? Or does it look like there’s no significant room for very strong growth? I can’t answer this question for you, but I can tell you to trust your gut above everything else. Don’t try to talk yourself into feeling one way or another about the answer to that question, just listen to your gut and follow it.

If it looks like there’s still significant gas left in the tank for the company itself to grow, hold the options for now. You should wait until the instant your gut begins to tell you that the skyrocketing is slowing down or is over, then exercise the options and sell the stock.

The reason is that when a company begins to show signs of slowdown in growth, their stock usually takes a pretty strong hit for a while as it stops being a growth stock and moves to being an ordinary or a value stock. This means the price to earnings ratio is going to go down rapidly, and if the earnings aren’t still growing rapidly, the only place for the stock to go is down – or at the very least, many years of sitting in the doldrums with no growth at all. In the long run, if the company is good, it will grow again, but it may take a very long time to reach its earlier heights.

Also, don’t worry about not hitting it at the exact perfect moment to maximize your dollar. The truth is that no matter what you do, you won’t time it perfectly unless you’re simply incredibly lucky.

Good luck – you’re likely to make some good money no matter what you do.

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