Employees today are required to make many critical decisions that have a material impact on their future. One of them is whether or not they should participate in their company’s stock purchase plan if offered.
Stock purchase plans are known alternatively as ESOPs, Employee Stock Ownership Plans and ESPPs, Employee Stock Purchase Plans. One advantage to participating is to get the discount that is offered which can be as much as 15% below the market price. Individuals who spend many years at the same firm accumulating company stock can end up with a nice nest egg if the stock performs well. Spending 20 years or more at a successful company can produce a substantial amount of wealth and that’s a good thing.
However, building a large position in your company’s stock isn’t the end of the decision making process. Say, for example that you’ve worked for your company for 25 years, are ready to retire and have a significant portion of your net worth tied up in that one stock. How are you going to manage that large stock position, known as a concentrated equity position?
One thing you can always do is nothing; you may decide to continue to hold the stock for long-term capital appreciation and collect the dividends for income. Maybe you want to hold it forever and pass it down to your heirs. There’s nothing wrong with that.
If you’re concerned about risk, however, and don’t want too much concentrated in one stock, you can sell the position or part of the position and diversify according to your needs. If you need to increase your income you may have to sell some shares and switch into investments that have a higher yield.
Now if you don’t want to sell your stock, but are still concerned about risk or have an income need, you might consider some options strategies to achieve your goals without liquidating your holdings. Options aren’t suitable for all investors and you should consult with your financial adviser to see if they are suitable for your situation — especially since a primary risk in options trading is volatility.
But, options might be useful in the accomplishment of some of your objectives without liquidating your legacy position. If you have to produce more income, you might consider selling covered calls against your position. Covered calls can produce immediate income on a regular basis and when coupled with a nice dividend paying stock, can create some steady cash flow. One disadvantage to the covered call strategy is that you’ll limit the upside potential of your stock. If you don’t want to limit upside potential, you can choose to only cover part of the position or use a credit spread instead, where you sell some calls and buy calls at a higher strike.
Options can also be used for insurance. If you are concerned about downside risk, but don’t want to sell, you can buy puts on your holdings and limit your downside exposure to a certain amount. Puts can be expensive and are kind of like buying insurance on your house, you hope you never need it,but if the house burns down, you’ll be glad you had it.
Another common strategy is known as a collar and just like the collar on your shirt, it can be tight or loose depending on how you like it. Now that you’re retired you might want to ditch the tie and go with the loose, comfortable collar. Anyway, collars are simple; you sell calls and use the proceeds from the calls to buy puts for protection. That way your upside is limited but the downside is also protected. Options involve risk, are volatile, and aren’t for everybody, but they might be a useful tool when you want to accomplish specific goals.
Consult your investment professional to understand the risks and to determine if the purchase or sale of these investments are appropriate for you and how they may be implemented to meet your investment goals. Options involve risk and can be highly volatile.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.
