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This
is the final part of my two part series on how financial advisors
and planners can benefit from understanding and using protective
option strategies (POS) to avoid or mitigate loses to their clients'
employee stock options and company stock. In the previous edition
of The Planner, I introduced and explained POs, the use of cashless
collars, best and worst case scenarios, and how to educate your
clients about cashless collars. If you missed the prior edition
or care to refresh your memory, please visit Part
1.
In
the final installment, I'll examine if there is any risk to educating
your clients about cashless collars and touch on tax issues related
to collars.
Will
Clients Try the "Do It Yourself" Approach?
One
of the risks in teaching financial strategies to clients is that
some will invariably try to do it themselves. Nowadays millions
of Americans pick their own mutual funds, stocks and even insurance
policies without the assistance of a financial planner, stockbroker
or insurance agent. Could the same thing happen if the 10 million
holders of ESOs are shown how to use cashless collars? It is doubtful.
In fact, by sharing your expertise in this area, it is more likely
that you will create clients for life. 
Collars
and other protective strategies are inherently more complex than
mutual funds or stocks. It is helpful to have an understanding of
issues such as volatility, trading ranges, when to buy puts and
when to sell calls, effects of market capitalization, time decay
of options, taxes and other market factors. Your client will need
your help in determining if he or she should sell $70, $80 or maybe
even $95 calls. Your client needs expert advice on the price of
puts to be purchased, and for what time period. Your client needs
to understand the importance of volume and liquidity in the options
to be traded. Of course they will need tax advice. They need your
help. If the stock rises in price and is called out at a 20% or
25% profit, your client will need to know where to invest that money.
They need your help. If the underlying stock is in a strong up trend,
you need to show your client how to customize the collar for maximum
benefit. Likewise, if it is in a strong downtrend, your client needs
to know what to do now to totally protect his or her net worth.
Finally, your clients will need to know if they should use collars
to protect 10%, 25%, 50%, 80% or more of their stock options and
company stock. They desperately need your help and financial expertise.
If you don’t help them, they could lose the majority of their net
worth.
Given
that most Americans have never even printed out an options chain,
employees with stock options desperately need your guidance on the
above matters. As you develop expertise in these areas, you will
distinguish yourself from other financial planners who cannot help
their clients protect their most valuable assets: their stock options
and company stock. You will become indispensable and will receive
many referrals to friend and coworkers of your clients. You are
not just a stock jockey or mutual fund picker. You aren’t just giving
generic stock options advice. You are actually helping your clients
insure and protect millions of dollars worth of their net worth
using these powerful techniques—and you are doing it at almost no
cost to them.
Tax
Issues
Prior
to helping your clients use POs, it's important to understand that
there are complex tax issues relating to collars. This is another
reason that clients will keep coming back to you for your expertise.
One such issue to consider is the Internal Revenue Code Section
1259, which deals with the “constructive sale” of appreciated financial
positions. The hedged position cannot eliminate the potential for
loss or gain. If it does so, the IRS could rule that a constructive
sale took place and taxes are owed. For example, if your IBM options
vest at $100 a share, you would not want to buy $100 strike price
puts and sell $100 strike price calls. It is true that your client
would be totally protected and have his gains locked in, but it
would probably be considered a constructive sale. While this tax
issue is complex and clear rulings have not yet been issued, it
is generally accepted that selling calls 15% out of the money and
buying puts 10% below the stock’s current price will preserve the
potential for gain and loss and will thus not trigger a constructive
sale.
What
if the stock appreciates and the call is exercised? In that case,
we have taxes on ordinary income on the gain in the price of the
call and the loss in the value of the puts purchased is a capital
loss (limited to a $3,000 deduction each year, with carry forward
allowed). Even many senior executives do not understand this. They
need your help. What if the executive had spent $200,000 purchasing
protective puts and the stock rises? Will he or she be writing off
this loss for the next 67 years? Not necessarily. Use your tax expertise.
Many executives have capital gains from other sources (other stocks,
apartment buildings, office buildings, etc.). Sell some of those
other assets. Take the gain. Eliminate some or all taxes by using
these put losses. You will be considered a genius and have a client
for life.
This
article deals for the most part on POs concerning stock owned through
the exercised of non-qualified stock options (NQSOs). While POs
can be beneficial for stock owned through the exercise of incentive
stock options (ISOs), the tax consequences are far more complicated
and beyond the scope of this article. If you're unsure of the taxation
effects of collars, consider contacting a stock option tax expert,
such as Net Worth Strategies, prior to developing a POS.
Conclusion
of Real Life Example
 How
powerful are these strategies? The stock of the NYSE company used
as an example in the first part of my article was approximately
$60 per share one year ago. Today, the stock of this industry leader
is less than $10 per share. The executives who utilized protective
options strategies have retained almost all of their net worth.
The employees who were given no guidance in how to use POs have
lost all or almost all of the value of their hard earned stock options
and have lost about 83% of the value of their company stock. Due
to the stunning losses employees have suffered in their unprotected
stock options and unprotected company stock, a record number of
stock option lawsuits are now being filed. Many of these lawsuits
could have been avoided if companies had given their employees basic
instruction in how to protect the value of their stock options and
company stock.
This
is a tremendous marketing opportunity for you. Companies are scared
to death to give any advice on stock options. In many cases, their
executives and HR departments don’t understand stock options. The
HR director at one high-tech company told me, “I don’t like options.
They are too risky.” As gently as I could, I explained to her that
the risk was in not using protective options. Employees at her company
had lost hundreds of millions of dollars because no one was showing
them how to use protective options. This spells a once in a decade
opportunity for you. You can do seminars showing employees how to
protect the value of their stock options and company stock. In doing
so, you can quickly gain tens of millions of dollars in new assets
under management, your clients will be able to protect their net
worth at low cost to no cost (no matter what the stock market does),
and the company will end up with happier, more loyal employees.
Plus, the company won’t have the public relations nightmare of having
to re-price its stock options. They will have immense respect for
you. This is truly a win-win-win situation for you, the employees
and the company.
Employees
who are educated in how to use protective options strategies will
be able to preserve and grow their financial fortunes and realize
their dreams even during these challenging economic times. A broader
use of protective option strategies could help preserve hundreds
of billions of dollars of the net worth of employees and in doing
so will strengthen our economy. In addition, many of these people
you have helped will become your clients for life.
Return
to Part 1
About
the Author
Dr.
Donald Moine is a well-known speaker and consultant to the financial
planning industry, and an industrial psychologist specializing in
compensation consulting and marketing with Association for Human
Achievement, inc. He has trained thousands of financial planners
and stock brokers over the past 20 years for clients such as Merrill
Lynch, Paine Webber and others. Dr. Moine also works on an individual
basis as a personal coach and marketing consultant, specializing
in helping financial planners build their practices. He may be reached
at DrMoine@aol.com or at (310)
378-2666
© 2001 by Dr. Donald
Moine. One time North American serial rights hereby granted to Net
Worth Strategies.
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