How to Make the Most of a Volatile Market
With high inflation, economic uncertainty, and the days of interest rates being near 0 seemingly behind us, the stock market has suffered. Market volatility is back and many employees who built significant wealth through their equity compensation plans now find themselves in a position where their company stock in some cases is down well over double digits. If this is you, here are some paths you can take to mitigate risk and even capitalize on the situation.
Evaluate Your Equity Compensation
The first order of business is to evaluate what type of equity compensation you have. Depending on the type of compensation it is, this can help you construct a game plan. For example, if you have RSUs and NSOs you could diversify as RSUs vest away from the company stock, but wait to exercise your NSOs if they are underwater. No matter what kind of equity compensation you have, it is critical that you fully understand how they work and how to plan during these times.
What You Should Know Before Exercising Your Stock Options Early
Don’t Just “Diversify” Your Stocks
One of my pet peeves in the financial planning world is the blanket advice planners and advisors give employees with equity compensation to diversify away from their company stock. Yes, the general rule of thumb is that no one position should consume more than 10% of your net worth. However, if you are an achiever and are passionate about the contributions you bring to your company, it is likely more than just stock. This is a company that you are committing hours of your life to. Perhaps you know the significance of what you bring to the table and how it can positively impact the company. That is why especially during these times, take a step back and think realistically about how much exposure you want for your company. If the stock were to go to near 0 would you still feel the way you do now? Only you can decide how much exposure that is, once you know that, you can plan more effectively.
Use Options to Your Advantage
If you haven’t checked out any of our options material, feel free to check them out here. Options can potentially be a way you can protect your position when the stock market gets volatile. There are 2 primary strategies you can use to protect yourself .*Please be advised, you will need to check your company policy on using options on your company stock if you are still employed by them*:
- Buy A Put – Think of this as pure insurance. You are essentially choosing a price that you would be okay selling your position at and buying insurance to ensure someone buys it from you at that price while your options contract is valid. Buying a put differs from just placing a traditional limit order in 2 key ways. 1. You pay cash out of pocket to buy the insurance. 2. If your stock goes below the strike price you don’t necessarily need to sell. You could decide to sell the put for a potential profit. For example, let’s say your stock is at $100, you buy a put with a strike price of $80. If the stock goes below $80 you can either sit back and relax and know that someone will buy it from you at $80 no matter what, or you can elect to sell your put on the open market and potentially make a profit
- Set Up a Collar – One of the big issues clients face with buying a put is the cost out of pocket. Depending on how volatile the market is, this can increase the cost of buying the put. To eliminate or reduce your out-of-pocket cost, you can construct an options collar. Here is what it can look like
- Sell a Call at a strike price of $120
- You own the stock at a price of $100
- Buy a Put at a price of $80
By selling the call with a strike price higher than the current strike price, you will receive income(premium) that can be used to offset the cost of buying your put. However, be advised that you now have set a cap on your growth. So in this example, while this collar is still valid you are guaranteed to not sell the stock below $80, however, if the stock goes above $120 a share you will not participate in any further appreciation.
Actively Tax Loss Harvest Your Stock
Employees with equity compensation who have accumulated shares over time will often have multiple lots of shares with various acquisition prices. This is when staying on top of market volatility is critical. By taking advantage of the ebbs and flows of your company stock price, you can potentially lock in losses on various lots. By locking in these losses, you have indefinite carry forward, can offset capital gains, and use up to $3000 of these losses to reduce ordinary income. The key here is that you don’t just simply want to take the loss, you want to either:
- Diversify into an alternative asset with similar growth prospects. For example, maybe you work at a tech company and there’s a fund with a similar correlation to your company stock. You sell the lots with losses and put the proceeds in this fund to increase diversification, lock in losses and potentially ride up a recovery.
- Sell the stock with a loss, buy a similar stock or asset for at least 30 days and then swap out of this position to buy back into your company stock.
- Sell the stock with a loss and simply wait in cash for 30 days to re-enter your company stock.
If you are currently employed by the company with this company stock, you will need to be careful following the rules about repurchasing the security. You will also need to be extremely careful regarding incurring a Wash Sale. The IRS Wash Sale rule prohibits you from selling an investment for a loss and buying the same or a “substantially identical” investment 30 days before or after the sale. A common way employees with stock in their company get hit with a wash sale is through RSUs. If you have RSUs vest 30 days before or after the sale of the stock you can potentially incur a wash sale.
Your Next Move
Coming up with a plan that incorporates all these different elements of stock management can be overwhelming. If you feel as if you need help, having a financial planner who specializes in equity compensation strategy can be helpful. At MDRN Wealth this is one of our specialties and would love to help in any way we can. Please feel free to reach out or schedule a call.