Many of the 11 million American employees

owning ESOs are looking for the answer to

that question. Certainly the predicament is

a good one, but can anyone help you make

the right decision?

In the view of this writer, some principles to

apply are below:

1. TRY TO AVOID A PREMATURE EXERCISE because premature

exercises forfeit "time premium" back to the employer and

cause early taxes.

2. If you want to reduce risk or take a profit, first determine

whether you own any company stock in your name or in

retirement accounts. If you do, then consider selling part or

all of the stock which gives you the best tax consequences.

Avoid selling stock which gives a short term capital gain

( unless you have capital losses to offset that short term

capital gain).

Selling (writing) covered LEAPs against the long stock

(or ratio writes) should be considered. In many cases,

it is superior to sales of the stock as far as overall risk

reduction is concerned.

3. If you have no or little stock to sell to reduce risk or

effectively take a profit on the ESOs, you should then

consider hedging your ESOs with "naked" listed LEAP calls.

You can do this by finding a broker who will accommodate

your selling "naked" calls.

Of course, the calls are considered "naked" only from

the broker's standpoint. But the written calls are not

"naked" from your standpoint as you know the calls are

sold to hedge your ESOs. Some brokers will allow "naked"

call selling in an account funded with as little as $5000.00.

Most will charge excess margin to discourage your selling

"naked" calls.They want you to be bullish.

4. If you have no access to cash or marginable securities

to use as margin for selling "naked" calls, then you should

probably just hold on to the ESOs and assume the

continuing risk. Only rarely will people, who own

substantial amounts of ESOs, not have access to cash

or other securities and have no company stock in

personal or retirement accounts.

It may sometimes make sense to prematurely

exercise a small amount of ESOs and sell if

the objective is to raise cash to fund the sales

of "naked calls". But that would be costly

if the stock is just 70% in the money with years to

expiration. The exercise and sale of stock and the

writing of the "naked calls" reduces risk and takes

profits.

5. If your stock has a very low volatility and

pays a nice dividend or if the time remaining on

your options is short, it may not be premature to

exercise the options and sell all or part of the

stock, even if there is substantial time remaining.

This is especially so if the employee is overly

concentrated in employer equity securities. The

option holder has to consider the tax

consequences of exercise and sale.

6. If the reason that the stock is up 70% is because there

is a takeover in progress, then you probably should exercise

and tender the received stock to the buying company.

Wait as long as you can to exercise because often

tenders and mergers fall apart with the stock subsequently

dropping. Your decision under these circumstances is tricky.

You will need someone with experience with options and

takeovers.

7. If you just need the money to pay credit card debts

at very high interest rates, or in the case of an emergency,

you probably should exercise and sell and suffer the

consequences of lost "time premium" and early tax.

8. The benefits of the strategy of systematic

"premature exercises", when the stock is

merely 70% in the money (or even 100% in the

money), in order to diversify your investments

is overstated. The forfeiting of the "time premium"

and incurring an early tax will reduce your

investable proceeds by perhaps 45% to 60%,

depending on the stock's expected volatility.

Remember:

Avoid a "premature exercise" and you're half way there.

John Olagues olagues@hotmail.com

www.optionsforemployees.com.

P.S. If you are prohibited from hedging ESOs with listed

options or futures, parts of these strategies may

not be available. A strategy of writing calls on

highly correlated stock may be the best way to go

under these circumstances. Email us for further advice.

There are only a few persons qualified to carry out

these strategies.

John Olagues

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