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Enron Mail |
Chonawee,
There are many interesting papers on executive stock options. Keep bugging me for them. Vince Chonawee Supatgiat@ENRON 07/10/2000 03:33 PM To: Vince J Kaminski/HOU/ECT@ECT cc: Subject: Re: short-sell vs exercise Thank you, Vince. I understand this tax effect already when you explained it to me in your office this morning. I agree with you that short-selling is not so good, especially for me, because I have a significant capital loss this year. I definitely don't want to increase my capital loss carry over. (The short-selling idea might work for a person who wants to exercise his options and already has a huge capital gain this year. Unfortunately, it is not me.) Thanks again for pointing this out. The "employee stock option with taxes" problem sounds interesting. I will think more about it when I have free time. -chonawee Vince J Kaminski@ECT 07/10/2000 01:57 PM To: Chonawee Supatgiat/Corp/Enron@ENRON cc: Vince J Kaminski/HOU/ECT@ECT, Stinson Gibner/HOU/ECT@ECT Subject: Re: short-sell vs exercise Chonawee, As I have pointed out, short-selling the stock may be a bad decision because of tax implications (ignoring the legal aspects). Suppose the strike is $70 and you were granted an ATM option. You sell short at $70 ten lots (one lot = 100 shares). The price goes to $100. You lose $30 x 1000 = $30,000 on your short position. Option exercise gives you $30,000. This is before taxes. You pay taxes on your option income (it's treated as ordinary income). The tax is 28% x $30,000 = $8,400. You can use only $3,000 of your loss against ordinary income. This saves you only $840 in taxes. Of course, if you have capital gains, you can use losses on your option position as an offset. The remaining part of your capital loss is carried forward and you get the tax benefits over time (less the time value of money), assuming you have income in the future (or capital gains). Not so good. By the way, valuation and optimal exercise of employee stock options is a very interesting and difficult problem. Vince Chonawee Supatgiat@ENRON 07/10/2000 11:40 AM To: Stinson Gibner/HOU/ECT@ECT, Vince J Kaminski/HOU/ECT@ECT cc: Subject: short-sell vs exercise Below is my writing that was originally planned to post somewhere. It explains how to handle a special type of call options which can be exercised but cannot be sold. (As we know that it is never optimal to exercise a call option before its maturity). However, after taking Vince's comments on the ordinary income/capital loss TAX offsetting issue, I think this is not a good article anymore. I guess I could just throw this article away. :-) -chonawee Short-selling is better than exercising your employee stock options In general, the sensible time to exercise your employee stock option is when you speculate that ENE is going down or its growth rate is extremely low. In fact, when exercising the options, you are speculating that ENE would never reach this point (plus interest) again during the 10 years maturity date or until you leave the company. If you do not anticipate that, you should hold on to your options because you can gain higher profit by delaying your exercise. However, if you believe that ENE is reaching its peak. Then, instead of exercising the options, you should short-sell (or sell) the stocks in that amount. After short-selling, when you feel that the stock starts to go up, you can buy them back (to cover), make profit, and still keep the options. On the other hand, if the stock does not go down as expect, you can exercise the options to cover your short position anytime. Let us take a look at a simple case where there are no taxes, no dividends, and zero risk-free rate. Suppose that ENE follows a simple sample path as follow If you exercise 100 ENE options with a grant price of 45 when ENE reaches 70, you would earn (70-45)*100 = $2,500. But if you short sell 100 ENE at 70, no matter how much ENE is in the future, you can exercise the options to cover the short position and still earn (70-45)*100 = $2,500. The advantage of short-selling comes when ENE at the period 2 is 60. At this point, you can cover your short position, get (70-60)*100 = $1,000, and still keep your options or you can exercise the options and gain $2,500. That is, you still keep the flexibility of your options when you short-sell. In conclusion, the only sensible time to exercise your employee stock options is to cover your short position.
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