E*TRADE Securities

02/28/19

Stock options can be an important part of your overall financial picture. Understanding what they are can help you make the most of the benefits they may provide.

How do options work?

Stock options, once vested, give you the right to purchase shares of your company’s stock at a specified price, usually called the strike or exercise price. Each option allows you to purchase one share of stock. The value of a stock option depends on the price of the company’s shares, which fluctuates over time.

A stock option is said to be “vested” when the holder has the right to purchase the shares at the predetermined price. Stock options may vest over a set schedule. Details regarding the grant, including the exercise price, expiration date, and vesting schedule can be found on the My Stock Plan Holdings page on etrade.com. You can access the Holdings page by hovering over the Stock Plan dropdown and selecting Holdings.

As an example, consider if you were given a grant of 100 stock options with an exercise price of $10 each. The options are fully vested after three years and the company’s share price has risen to $25. You are now entitled to exercise your options and buy the shares for $10, a full $15 below the current stock price. This process of purchasing the shares underlying the option is known as ‘exercising’ the option.

Know the types of stock options

Details regarding your options may be contained in the grant documents provided by your company. Before taking action on your stock options, review the company’s plan documents on the Company Resources page (Stock Plan > My Account > Company Resources). The type of stock options you have been granted will also be indicated in a column on the My Stock Plan Holdings page (Stock Plan > Holdings) on etrade.com.

Exercise types

Same-day sale (Cashless exercise):

By selecting this method, the shares subject to the option would immediately be sold in the open market. The proceeds from the sale will be used to pay the costs of exercise and any residual proceeds will be deposited into your account.

Cash exercise (Exercise & hold):

By selecting this method you would need to deposit funds into your account to cover the costs of exercise. Resulting shares will be deposited into your account.

Sell-to-cover:

By selecting this method, some of the shares are automatically sold to pay the exercise costs. The remaining shares (if any) are deposited into your account.

US tax considerations

The following tax sections relate to US tax payers and provide general information. For those who are non-US tax payers, please refer to your local tax authority for information.

Before you take action on your shares, you’ll want to carefully consider the tax consequences. The information contained in this document is for informational purposes only. Tax treatment depends on a number of factors including, but not limited to, the type of award. For advice on your personal financial situation, please consult a tax advisor.

Potential taxes on exercise

ISOs: In most cases, no taxes are due at exercise.

NQs: Taxes at exercise are based on the difference between the stock price on the date of the exercise and the option exercise price. This amount is typically taxable in the year of exercise at ordinary income rates.

Potential taxes at sale

ISOs

Ordinary Income: The amount of ordinary income recognized when you sell your shares from an ISO exercise depends on whether you make a qualifying or disqualifying disposition. A sale of shares from an ISO exercise can be considered a qualifying disposition and possibly result in favorable tax treatment if, among other requirements, the following conditions are met:

  1. You hold the shares for more than one year after the date of purchase (the exercise date), and
  2. You hold the shares for more than two years after the option grant date.

Capital Gain or Loss: In general, selling shares from an ISO exercise in a qualifying disposition will not trigger ordinary income and the entire gain or loss (sales price minus cost of the shares) will be considered a long-term capital gain or loss.

If you fail to satisfy the requirements described above, your sale of shares from an ISO exercise might be considered a disqualifying disposition. In general, selling stock in a disqualifying disposition will trigger ordinary income. The amount of ordinary income is generally the difference between the stock price on the date of the exercise and the option exercise price. Your employer should report the ordinary income from the disqualifying disposition on your Form W-2 or other applicable tax documents. Any remaining gain or loss will be considered short- or long-term, depending on how long you held the shares after exercise. If you held the shares one year or less, the gain or loss would be short term. If you held the shares more than a year, the gain or loss would be long term.

NQs

Ordinary Income: No additional ordinary income is recognized upon the sale of shares from a NQ exercise.

Capital Gain or Loss: Any difference between the stock price on the exercise date and the stock price at sale will be treated as a capital gain or capital loss. If shares are held for more than one year after exercise, any resulting gain is typically treated as a long-term capital gain.

Potential taxes on dividends

If you exercise your options and hold the shares, any dividends received on your shares are considered income and are taxed as such in the year they are received.

A closer look at potential tax scenarios for each option type

This example assumes a $10 exercise price on a grant of 100 options. The stock price at exercise is $25. The stock price at sale is $45.

Option type Taxes at exercise Taxes at sale
ISOs

In most cases, no taxes are due at exercise

Scenario 1: Qualifying Disposition:

$45 - $10 = $35

100 shares x $35 = $3,500 taxed as capital gains (long term)

Scenario 2: Disqualifying Disposition:

100 shares x ($25-$10)

= $1,500 taxed as ordinary income

$45 - $25 = $20

100 shares x $20 = $2,000 taxed as capital gains (long term or short term depending on how long shares were held)

NQs

$25 - $10 = $15

100 shares x $15 = $1,500 taxed as ordinary income

$45 - $25 = $20

100 shares x $20 = $2,000 taxed as capital gains (long term or short term depending on how long shares were held)

Exercising your options

Once you exercise your vested options, you can sell the shares (subject to any company-imposed trading restrictions or blackout periods) or hold them until you choose to sell or otherwise dispose of them.

Follow these steps to create an order to exercise your options and hold or sell your shares:

Create order

  1. Log on to etrade.com. From the Stock Plan Overview page, click the Exercise tab
  2. Choose to exercise your options and hold or sell the resulting shares by selecting one of the following:
    1. Cash: “I’d like to sell the resulting shares and receive cash”
    2. Shares: “I’d like to receive shares”
  3. If you choose cash, choose your price type by selecting one of the following:
    1. Market: “I’d like to sell at the next available market price”
    2. Limit: “I’m willing to wait until the stock reaches a specific price”. This type of order can be good for one day only or “good-until-canceled.”
  4. If you choose shares, choose how you would like to fund the exercise:
    1. Sell-to-Cover: “I’d like to sell shares to cover the cost of the exercise”
      1. Market: “I’d like to sell at the next available market price”
      2. Limit: “I’m willing to wait until the stock reaches a specific price”
    2. Cash/Margin: “I’d like to use cash or margin to cover the cost of the exercise”
  5. Choose options to exercise: Enter the number of options you would like to exercise from the available lots
  6. Select how you would like to receive your proceeds

Preview order

  1. Review your order and estimate your proceeds by clicking the Preview Order button
  2. From the Preview Order page, you can change or cancel your order. Click Place Order when you are ready to place your order

Confirm order

  1. You will receive a confirmation that your order has been placed

We’ll alert you when your order has been executed and when settlement occurs.

You can also track your order status on the Orders screen (Stock Plan > My Account > Orders) on etrade.com.

Have questions?

Customer Service is available Monday to Friday, 24 hours a day, online at etrade.com/service or call us at 800-838-0908. From outside the US or Canada, go to etrade.com/contact to identify the phone number for your country. One of our dedicated professionals will be happy to assist you.

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