"Diversify, Diversify, otherwise you'll end up like the

holders of Enron or Worldcom" goes the refrain.

Lets take a closer look.

Companies want their employees to hold lots of company

stock and options in every form and manner allowable.

There are tax incentives and company incentives to

load the employees up with stock and options.

Equity compensation plans are designed to encourage

loyalty, longevity and low costs and minimum cash outlays

from the employer.The employees after years of loyal

work often find themselves with stock, options and

other forms of equity compensation, which they neither

understand nor know how to manage.

So they go to Financial and Investment Advisors for help.

These advisors see that the employee is over exposed in

the company stock and options because that's the way

the employer wants it.

Yes, it's risky to have all your eggs in one basket. But

what if the biggest eggs in the basket are employee stock

options. You can't trade your company ESOs for a diversified

fund of Employee Stock Options of other companies and you

can not sell the ESOs.

The only thing you can do is a) prematurely exercise the

ESOs and sell the stock received or b) reduce the risk of holding

the ESOs by selling stock of the employer that you may own

or c) by trying to hedge the ESOs or stock  with listed options

on the employer stock. d) You may even consider "writing" calls

or "collars" on a basket of related stocks.

Here's an example:

1.Non - qualified ESOs are granted to buy 10,000 shares at $50

2.Stock is trading at $80 two years after the grant.

3.Assumed Volatility equals 40, Interest rate is 4%,

no dividends are paid.

4.The Theoretical value of ESOs is $470,000.00 with the

market price of the stock at $80.00.

5.Net cash after tax if options are exercised and stock sold 

would be $180,000.00. If $180,000.00 worth of stock is

retained after paying the tax and exercise price, the tax

consequences would be the same.

6. Assume that stock doubles to $160.00 at expiration of

the non - qualified ESOs.

7. After tax proceeds from the ESOs would be

$1,100,000.00 x .60 = $660,000.00

8.The After tax value of the retained stock would be

$360,000 - $36,000.00 tax = $324,000.00.

9. If the assumed price was higher the result would be

a greater result favoring holding the ESOs to expiration.

10. If the stock was at 80 on expiration day the

results would be equal.

11. Any price lower than 80 would have favored the

exercise and sale strategy, unless there was some

hedging strategy carried out.

12. On the other hand, assume the early exerciser sold

all his stock and diversified his investment into other assets.

Assume those assets were double in value on the date of

expiration and the entire gain was subject to long term

capital gains tax. The net result would have been the same

as if he had retained the remainder of the employer stock after

selling enough to pay the exercise price and tax.

So the cost of diversifying would have been very large

because you would be starting about 50% with less value.

John Olagues

http://www.brighttalk.com/dcemail_redirect/webcast/5906

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470471921,descCd-google_preview.html