How to Profit from Employee Stock Options Regardless of Share Performance

by Darwin on March 24, 2009

For workers fortunate enough to be granted employee stock options each year as part of their compensation package, of late, this has been a bittersweet perk.  While it’s nice to have an opportunity to enjoy a leveraged return and share in the success of your company’s share price, the vast majority of employees have seen their options either languish in “out of the money territory” or expire worthless during the past several years.  Well, there is a way to make money on these employee stock option grants regardless of what happens to the company share price.

Employee Stock Options Explained

As part of a compensation package meant to reward employees for making moves that benefit the company’s share price, rather than silo thinking, many companies offer employees an option grant as part of their annual compensation (or more often as it merits).  On a given day, if a stock is trading at $100 per share and an employee is granted 500 shares, what that means is that the employee can now profit on any movement above $100 at a rate of $500 for every $1 that the share price moves.  If you consider that the long-run return of US equities is around 9%, if your company’s stock miraculously performed at exactly a 9% return per year, that grant would be worth $4,500 at the end of the first year, over $9,000 at the end of the second and so on, until the grant is exercised.

Some companies allow up to 10 years until a grant must be exercised.  In the example above, at 9% per year, an employee would be looking at $68,000 for just that one year’s grant.  If rolling over each year’s grant 10 years out, how’s a $70,000 bonus sound?  Not bad right?  Well, that’s not how it’s been panning out for many employees each year in a down/sideways market.  If the share price drops from $100 to say, $90 at the end of the 10th year, nothing.

How to Lock in Profits on Employee Stock Option Grants Regardless of Share Price Performance

Similar to the example above, let’s say you’re an Apple employee.  As of the date of this post, Apple shares closed at $107 per share.  Let’s say that similarly, you were awarded a stock option grant of 500 shares this year.  These options vest immediately and are good for 5 years.  If you go back a year, Apple was trading at $140, so you may be questioning why you continue to hold options each year when you may want be assured that you’ll get at least something each year for your grant.  In order to do this, you can sell call options against your underlying option grant on a 1:1 basis (or less if you want to be conservative in your approach and/or retain the ability to enjoy a payday if shares run up to $200 again).

If you wanted to be able to capture some of the upside, but ensure some immediate income as well, you could do the following:

  • Recieve option grant for control of 500 shares at $107 strike – immediate vesting
  • Sell 500 call options with Jan 2011 expiry at the $130 strike for $1983 each (contract controls 100 shares)
  • This will net you an immediate $9915
  • The $130 strike also allows you to participate in some decent upside before the sold calls hit at $130 (130-107)=23…x500 share control = $11,500

To recap,

  1. If shares in Jan 2011 do nothing and stay at $107 or end lower, instead of having nothing to show for it, you’d have the $9915 in initial option premium and you could re-execute the whole strategy again for say, Jan 2013 strike.
  2. If shares move up marginally and close at something above $107 but less than $130, you get the $9915 + 500xdifference in share price for a max of $9915+$11,500 = $21,415
  3. If shares rocket past $130 at the time of expiry, your max gain here would be the $21,415, while if you did nothing, they may have been worth much more (unlimited upside – that’s the tradeoff!).
  4. Note, you CAN react to a rapid upside move to prevent your sold calls from being “called” on you prematurely.  You could always buy back the $130s and sell something higher, like say, $150s to replace the cash outlay your just utilized.  In the end, you’ll still end up ahead as long as this isn’t a weekly occurrence.  As this is a rather complex and unlikely scenario, perhaps understand the concept and potential, but in order to avoid altogether, just sell calls further out of the money, like say, $150 if that’s a serious concern of yours.

How Do I Sell Call Options?

First, you need an online broker.  Open an account at TradeKing. for the lowest-cost options at SmartMoney’s#1 rated discount broker.  You won’t need complex trading platforms and customer service that come at a higher price with E*Trade or Ameritrade.  Now, in this case, because your online broker won’t just “take your word for it” that you have an options grant in another account from your employer, you’ll need to have a margin account with the ability to sell shares short.  Generally, upon signing up for an account, you would need to sign a form stating that you understand the risks of options trading and selling short.  It’s easy enough to find the form in your account settings or email customer service and they’ll send it to you. You would also need to have some collateral in your account.  If you’re not a trader, you could actually just leave some cash in the trading account money market, open a CD or leave it parked in some other equity with little volatility.

Remember, if the vesting period is say, 1 year minimum (meaning that during the 1st year, no matter what happens to Apple’s share price, you can’t exercise those options), ensure that you sell a call with an expiry AFTER your options vested so you DO have that collateral to exercise at your disposal.  So, if you were granted options on Jan 1, 2009, the earliest call options you should sell would be Jan 2010 strike.

This is an exercise in Tradeoffs.  You can trade immediate guaranteed cash but forgo a payday later if your company’s stock rallies.  Conversely, if you choose to “let it ride”, you may end up with nothing to show for your hard-earned stock option grants.

To Stay Up to Date with other Financial Models and Ideas, make sure to Subscribe via RSS (what is RSS?).

You may also enjoy these articles on Exploiting Volatile Stock Earnings with Options or Net Present Value in Everyday Life.

*Note – If you’re considering employing this method, consider that a) you may be leaving some upside on the table if shares move upward quickly; b) you may have your short calls “called” on you if you can’t yet exercise your underlying grant while shares run up; c) if you don’t fully understand all the scenarios that may manifest themselves, you should seek professional advice prior to attempting this.

You're Not Following Darwin's RSS? Check out Why You Have to Subscribe to Darwin's Finance!

If you enjoyed this post, you can get free updates through RSS Feed or via Email whenever a new post is published. Rest assured that you can unsubscribe at any time via the automated system and your information will not be sold, archived or utilized for any other "nefarious" purposes.

{ 7 trackbacks }

OneMint - Economy and Your Finances - April 5, 2009 | OneMint
April 5, 2009 at 3:03 am
The Enlightened American » 135th Edition - The Festival of Stocks
April 5, 2009 at 10:18 am
ABCs of Investing
April 5, 2009 at 10:14 pm
Carnival of Twenty Something Finances: NCAA Final Four Edition 4/6/2009 | Weakonomi¢s
April 6, 2009 at 6:17 am
The Money Hacks Carnival #59 - The Duct Tape Edition | Greener Pastures: Personal Finance
April 8, 2009 at 5:14 am » Blog Archive » Investment Talking
April 11, 2009 at 7:25 am
Personal Finance Articles this Week from Personal Finance Blogs | Personal Investment Management and Financial Planning Blog Directory
August 4, 2010 at 3:22 pm


1 Francis March 25, 2009 at 10:14 am

Almost all option grant contracts forbid employees from trading options.

2 Darwin March 25, 2009 at 3:44 pm

I’m not sure I agree. My company’s grants are simply a piece of paper with your compensation for the year saying grant price, date, expiry period, etc.

Insider trading is one thing. That would entail making trades on either company stock or options while in material possession of knowledge not available to the public. That’s a separate issue than this topic though. Sitting on an option grant and selling options against that collateral while NOT in material possession of insider knowledge and collecting time value premium as it erodes…I don’t see how that would draw scrutiny from the SEC or company policies. I also don’t see how that would be enforced or tracked. Not that it’s OK to violate procedures in that case, but I’ve also never heard of anyone being reprimanded for selling calls againts their own company simply for hedging purposes; I presume people do it all the time. Please elaborate on the actual rationale for concern. Perhaps I’m missing something; thanks for the comment nonetheless, this topic will be of interest to readers as well I’m sure.

3 the weakonomist March 25, 2009 at 6:33 pm

I’m interested in knowing as well. Perhaps this would make for a good follow-up article. I don’t have options right now in my career, but it’s only a matter of time before I do.

4 Darwin March 26, 2009 at 7:22 am

I found this answer from an attorney that didn’t seem to think there were any concerns from a “legal” standpoint on buying puts vs. employee options (not really any different than selling calls from a company policy standpoint concept) and instead just referred to a financial advisor.

5 Francis March 26, 2009 at 10:52 am

check with your employment contract (some companies even forbid you from owning stocks in competitors or trading partners). And yes, it is perfectly legal — you don’t have to work for that company.

Now most companies will have a covenant that you need to sign in order to get your grants. It will specify what the rules are. Companies look bad when their employees are trading against them. How would it look if your directors shorted the company stock outside the blackout period? And the option grants are to align the interests of the employees, managers, etc… along with the managers so that they are long with the company. Hedging takes that away. For these reasons, the covenants rule out derivatives trading.

This is not an SEC ruling but a contractual and policy issue between the employee and the company.

6 Darwin March 29, 2009 at 2:57 pm

I would just say honesty’s the best policy then, and if your company does have a policy, obviously, follow it. If they don’t and you’re unsure, it wouldn’t hurt to ask. Chances are the people you ask won’t even understand the concept of what you’re trying to do. But if there’s no policy and nobody tells you NOT to do it, then decent opportunity here. I couldn’t find anything within our policies or on my grants that ever prevented selling covered calls; but presumably there are companies out there more sensitive to this.

Francis, I see the point of the “perception” of selling your own company shares, etc. However, is it any different than when you get a restricted stock grant and sell it right away? For the plans that don’t have a vesting period, some employees just dump the shares right away and take the cash instead of hanging on to them which was the intent of giving employees the shares.

I view it as a diversification strategy – you already have your salary, your bonus and your livelihood tied to the company – why double dip by having excess options, owning company stock, etc., as opposed to diversifying?

7 Jorge April 8, 2009 at 6:30 pm

Darwin, I loved this post. It is a great idea and makes complete sense. In reference to the discussion above, at my company there is no restriction against this type of thing. Once the options are vested, they are yours to do with as you with.

Thanks for the great tip, I’ll be exploring how to leverage this in the near future!


Jorge’s last blog post..Five Financial Moves You Should Make Now (and Five You Should Not)

8 Darwin July 18, 2009 at 2:17 pm

Joe at ioptions contacted me to highlight a recent SEC ruling that allows who own stock options to generate income from their unexercised holdings. According to the article, “Until now, employees couldn’t conduct these trades without owning actual shares in their companies or ponying up a certain amount of cash as margin.”

Interestingly, while this article speaks to the margin issue, in effect, it endorses the legality of the concept above then, right? I mean, the SEC has now gone even a step further in dealing with a margin issue and skipped right over whether employees should have even been doing it in the first place.

This will create an interesting situation for companies that do have a policy prohibiting it as mentioned by some previous commentors. You’ll have a company telling you that you can’t do something that the SEC says is legal.

As always, just check with HR on your company’s policy if you’re unsure as to whether this will land you in trouble.

9 Frank August 7, 2009 at 3:19 pm

I have some employee stock options of the company I work, so this article s of great interest to me. However, when I called ETrade and TradeKing, the trade representatives of both of the companies told me that cannot be done, i.e., I cannot sell call options against my employee stock options without exercise them first. What’s the story?

10 Darwin August 7, 2009 at 11:24 pm

Here’s the deal (since I’ve been able to do this through Ameritrade myself) – I don’t think the brokerage even needs to know whether you’re holding company stock on the other end. This is essentially a “naked call” selling exercise. For all Ameritrade or whoever knows, you do or don’t have some long options elsewhere in your holdings. What you’ll need is margin and the higher level of options allowances that allows you to short stocks, sell “uncovered” or “naked” calls/puts, etc., and with that in hand, as long as you have adequate capital in your account (which can just be investing in long positions elsewhere, cash or whatever), you should be able to do it. Now, I can’t speak for which brokerages allow individual investors this level of leeway and which don’t. I did just sign up for Tradeking ($50 bonus here too!) but my old account with Ameritrade currently has multiple “naked” short positions – they’re hedged with other instruments of course, but I don’t hold the underlying instrument long. I think if you either a) phrase the question more like “with the right approvals and capital, can I sell options without the underlying securities” or b) just use Ameritrade, it should be doable.

Hope that helps; please come back and update on your findings so other readers can see what their options are (no pun intended) and whether other online brokers allow like Ameritrade (since they’re a bit on the expensive side these days).

11 Frank August 11, 2009 at 12:15 am

Thank you for your quick reply. What you said makes sense. The only issue I can see is that there is no way to link the filling of the naked call with the exercise of the employee stock option, since the blockage, say Ameritrade, handles the naked call will not be able to sell the employee stock option which is held at another blockage, say Etrade. Of course, it is only slight increase in risk factor but nevertheless not perfect. Moreover, I am work full time so may not be able to do these trades in real time.
I don’t have much experience in option trading and my allowed option trading level is low right now. I need to find out how to increase my trading level first.
Thanks for your help anyway.

12 Darwin August 11, 2009 at 8:45 am

Hi Frank,
Given the long durations involved in such activities, I didn’t view it as high risk. I have one trading account, and then my employee options are held in some other account that the company established, Citi or SmithBarney or something. Anyway, if you want to avoid any volatility that may occur in a single day (which will likely be small if your horizon was say 1 year out – i.e. a stock may move 25% in a year up or down, but may move 1-2% in a day), you could always just have two browser windows open, execute the trades around the same time and you’re just about net even on exercise price. If your company only exercises options based on the price at close of trading, you could close the options transaction right at 3:59PM. So, a few options out there to mitigate the timing risk. Hope that helps!

13 Frank August 18, 2009 at 1:47 pm

Hi, Darwin:
I opened a TradeKing account based on your suggesting. Even it is only a few days, I feel their customer service is really great and everything are handled perfectly, as far as I can tell. BTW I am usually a picky person. Let’s see how well they handle my tradings in the future.
One issue I have is that since I don’t have much option trading experience, I am not qualified to do naked calls. Someone suggested that i can do a spread by write a call equivalent to the naked call I want to do and then buy a call at higher price to cover it. If the second call is much higher, it will not cost much. Spreads requires lower option trading level then naked calls because they involve less risk. Do you think this will work? Thanks again for your good suggestions that led me to start this effort.

14 Frank August 19, 2009 at 4:02 pm

I just found out that there is an item in my company’s insider trading policy that prohibits an employee doing short sell of company stock. Covered call is not viewed as short sell but uncovered call is. So if anyone want to do option against your company’s stock option, you need to check you company’s policy first, if you don’t want to get into trouble.

15 Darwin August 19, 2009 at 10:37 pm

Hi Frank,
TradeKing’s good; not sure if you caught my note in other posts – anyone that wants a free $50 for signing up with the best anyway can get the bonus through August by doing the following:

You just need to deposit $1000 and execute a trade by August 27. It’s that simple (free $50 plus the best rate on trades!).and you want to partake in the $50 Tradeking bonus through August

* Contact me using the contact form at the top of this page,
* Make sure to put your email in there
* You’ll get an email from Tradeking with a link to activate!

It’s that simple!
On the company issue, yes, varies company by company – mine was silent on the topic, so I figure no policy against. If in doubt, check it out!

16 Mike December 1, 2009 at 5:33 pm

you can do this and we do it as a good part of our team’s business. It operates with the same logic as a 10b5-1 plan. [email protected]

17 شات مصر May 1, 2011 at 12:02 am
18 sohagonline May 1, 2011 at 2:52 am

Comments on this entry are closed.