What strategies should you be considering when a large portion of your net worth is tied up in unvested employee stock compensation?
As with any financial planning situation, the first step is to have a clear picture of your overall net worth. Although your employee stock compensation may be unvested, if you anticipate you will remain employed with the company throughout the vesting schedule, you should treat the stock as an illiquid position included in your portfolio.
Chances are if you include that unvested position in your overall portfolio across your various accounts, it represents a large portion of your overall net worth. As always, concentration builds wealth, and diversification maintains wealth.
If you’re still trying to determine if you should be diversifying your concentrated position, I encourage you to read my prior posts:
Assuming you’re comfortable with your path to financial independence and want to diversify your employee equity, then consider the following strategy:
If you’re highly concentrated in unvested employer stock that’s highly speculative — it’s worth considering the cost of a put option strategy (if permissible).
If you’re content with your path to financial independence, you can hedge the position over your vesting schedule. pic.twitter.com/BX81Uj3LLr
— T.J. van Gerven (@TJvanGerven) January 7, 2021
What is a put option?
“A put option is a contract giving the owner the right, but not the obligation, to sell–or sell short–a specified amount of an underlying security at a pre-determined price within a specified time frame. This pre-determined price that buyer of the put option can sell at is called the strike price.”
If your company’s stock is highly speculative – meaning, it typically experiences drastic price movements and does not have a long history of generating profits (if at all), then it could be worth exploring the cost of put options if you’re already planning on selling your employee stock when it vests.
There are a few caveats with this strategy. First, you need to confirm that you’re allowed to make transactions with your company’s stock in your personal account as an employee. This would include restrictions for blackout periods and open trading windows (or if you’re allowed to purchase put options specifically).
From the employers’ perspective, it could be a bad optic if you’re looking to purchase put options since you’re technically betting against the stock’s continued appreciation.
That’s not the point. Purchasing put options in this scenario is about hedging your current position and “locking in” a portion of your wealth. Essentially, purchasing put options is insurance on your current long position in the company stock. The reason for purchasing the put options is because your shares are not currently available to you. If they were, you’d simply sell.
Whenever you are looking to transfer risk through some type of insurance, you need to consider the costs of transferring that risk.
With respect to a put option strategy for locking in a portion of your unvested wealth, you’d need to consider the premiums’ cost to purchase options. The price is dependent on a variety of factors but is primarily influenced by the time until expiration and how volatile the stock is.
The longer out in time you’re looking to purchase an option, and the higher the underlying stock’s expected volatility, the higher the cost to purchase the options.
The cost of purchasing put options on your company’s stock over a time period where you’re waiting to receive access will depend on both the specific stock and your personal financial situation.
Regardless, it’s a strategy worth considering if you feel like you’re on track to financial independence and are looking to hedge your concentration risk before receiving access to your shares.
As always, make sure to consult a professional before implementing any of the strategies discussed.