Different Methods of Buying Your Employee Stock Options

When employees exercise their stock options, they buy shares of their company’s stock at a predetermined price (the strike price), typically below market value. Here are the ways that employees typically cover the exercise cost: 

1. Cash Payment: The employee can pay the exercise price with cash. This straightforward method requires the employee to have enough cash available to cover the entire cost.

2. Cashless Exercise (also known as a “sell-to-cover”): If an employee doesn’t have sufficient cash, they might opt for a cashless exercise. This involves working with the company that holds your stock options (Fidelity, Schwab, etc.) to front the money needed to purchase the shares. Then, enough shares are immediately sold to cover the exercise price, taxes, and brokerage fees. The balance of the shares is transferred to the employee’s brokerage account, which you can either retain or sell.

3. Stock Swaps: Some plans allow employees to use existing company stock to pay for the exercise cost of the new options. This means they exchange some shares they already own for the right to purchase more shares at the strike price. This avoids the need to provide cash up front.  This tends to be a very complex strategy but can have significant advantages if used properly.

4. Net Exercising (also known as a “cashless hold”): Sometimes, a company may allow the employee to receive fewer shares without needing cash or selling shares immediately. The number of shares the employee receives equals the net value of their stock options after deducting the exercise cost and required taxes.

Each approach comes with its benefits and possible drawbacks, especially concerning taxes. If you’re mulling over exercising stock options, engaging with a financial advisor and/or tax advisor is crucial. They’ll provide insights tailored to your situation. Remember, not all companies offer every method, and your options might be dictated by the terms outlined in your stock option agreement. 

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