Our descent into the stock-market inferno

David recently called me with terrifying news: "I'm going to exercise my stock options!" My response -- you have stock options!?!

Turns out his company, A Giant Madison Avenue Ad Conglomerate, chucked a handful of options at staffers about five years ago. They've recently vested. Although Giant Conglomerate's shares are trading dead flat to where they were five years ago, David's options carry a strike price of about half the current value -- so, if he exercises the options and cashes out, he'll see a profit. (A fairly tiny profit. Like, a rounding-error-on-Google-shares size profit.

Since neither of us has ever mucked around with the tax implications of anything related to stocks, I promptly wigged out. "Exercising stock options" is irrevocably linked in my mind to complicated tax situations and debacles with the AMT. "Whatever you do, do not exercise and hold the options!" I fretted at David.

I don't pretend to have looked in any detail at the minutia of how it works, but my understanding is that when you exercise options, you're taxed on the 'profit' of the difference between your strike price and the market price -- even if you end up holding onto the shares and not realizing any actual-cash profit. If, as happened to so many during the dot-com smashup, the shares you own then tank, you still owe on what they were 'worth' on your exercise date. So why would anyone exercise shares and not immediately sell them? If your options are expiring but you want to gamble on the shares going higher, you can buy and hold. It can also result in a lower total tax burden if you hold the shares for more than a year, shifting the gains into the capital-gains category (which can come with a lower tax rate than you pay on your regular income).

But I have no interest in gambling on Giant Conglomerate's shares climbing, and given the tiny sums at stake here, trying to game the tax rates would save us about enough to buy an extra box of cat food. So my vote was firmly cast in the "exercise and dump" category.

My next fret was about the logistics of that -- would we need a brokerage account? An accountant? I just write about stocks, I've never tried to do anything so silly as selling them ...

Fortunately, David's company is apparently prepared for having a workforce with no clue about these things, and has an arrangement struck with the financial institution handling the stock-option deal. Employees can arrange for their options to be exercised and sold simultaneously, with the tax withheld. We'll just get a check for the net amount, and presumably some paperwork for the IRS next year around tax time.

I haven't seen any of the paperwork on this -- David and his company are handling it. It still feels rather nebulous; I'm viewing the whole thing as a rather novel experiment. Now if only my company would start talking about spin-offs and IPOs, it'd really feel like 2000 all over again. Maybe I too will eventually get some of these newfangled stock option things.