Avoid the $250,000 station wagon syndrome with your stock options
When I was a tech executive in Silicon Valley and Texas, my financial advisors never talked about a specific type of risk that I personally faced when trying to manage my stock options - the Risk of Regret. It was always stressful when trying to decide if I should exercise and sell now, or wait. Here in the San Francisco Bay area, stock options are a common form of financial incentive for attracting top talent, and the Risk of Regret can be enormous. If the stock price goes up after you sell stock, you kick yourself for not holding on. If the price goes down, you wish you had sold more. It seems the risk is high either way.
It’s one thing to discuss this risk with a client, but having actually lived through the experience with my own stock options, I’ve learned some important lessons that can’t be learned in a textbook, and isn’t covered by financial industry jargon. Which is why most financial advisors don’t spend enough time managing this risk.
Risk #1: The Regret of Buying a $250,000 Station Wagon
It was while I worked at Compaq Computer in its glory days that the “$250,000 station wagon” became a thing. One of my colleagues joined Compaq in the early days and received an option grant at a very low price. At some point, he needed a new car for his growing family, so he exercised some options to buy a shiny new station wagon. With the success of Compaq and its stock price those options he exercised for the family car were later worth nearly a quarter of a million dollars! You can imagine the regret he felt, kicking himself for not waiting longer before exercising. The “$250,000 Station Wagon” became a legendary story back then, and I often thought of it when I wrestled with the decision to exercise my own options, along with many other people. In today’s world of Apple, Facebook, NetFlix, Amazon, etc, that $250,000 station wagon is more like a $1 million SUV.
This is the first example of the Risk of Regret - exercising options, spending the money, and watching the stock price rise.
Risk #2: Opportunity Down the Drain
The most gut-wrenching experience is when the stock price reaches a new high and then pulls back 10%-20%. Will it continue and then free fall into a downward spiral, or will it bounce back? Once a stock hits a certain price level it’s very easy to expect it to hit that price again. Unfortunately, that doesn’t always happen.
Wall Street history is full of companies whose stock prices never lived up to their hype, even after a successful IPO. Employees of Groupon would have fared better if they sold all of their stock as soon as possible after the IPO. Groupon stock has been on a long, downhill slide since going public. Even worse, there are companies such as Complete Genomics, Mattress Firm, or Genitope, whose stock prices languished until they were bought out or went out of business.
This is the second example of the Risk of Regret - not exercising options and then watching the price drop until the value of the options is minimal or even worthless.
Is There Any Way to Develop a Good Stock Options Strategy?
If the Risk of Regret is so high with stock options, is there a winning strategy? The short answer is “yes,” but the solution is different for each person. Just because your colleague at work exercised all of their options doesn’t mean you should.
A solid strategy factors in three major aspects:
Managing emotional risk.
Some of the factors I consider when developing an exercise strategy for my clients are:
Personal need for capital
Blackout periods for trading
Other risk considerations for those deemed company insiders
The volatility of the stock
Current market sentiment and momentum
The company’s expected growth and success
A comprehensive plan is well worth all of the work to simplify the complexities and strike a balance among all of your priorities.