Sunday, October 1, 2017

The delusion of employee stock options

You can only get rich on employee stock options. That is why in order to make money you have to work for a large high-tech company or big oil. Well, not entirely. You see first, employers give less and less stock options to employees. Now they give ‘free shares’, or whatever – their costs are still paid out of your gross salary, one way or another.

I am telling you that you can own similar options and you don’t even have to work!  You can stop having that job that you hate. Don’t hang-around because of fear of losing your options.  There are call options and put options available for you to buy in the market and they don’t have to cost a lot… and you don’t have to deal with the complexities of employee stock option taxation!
You have to realize that stock options only work if your company’s shares go up in value. Basically, they are long term call options.  If you own a call option it gives you the right to buy a share of the ‘underlying’ company for a certain price – the strike price. If you buy a call option, i.e. the right to purchase a stock at the current market price for the next year or two; or better for the next five years then effectively you have the same as an employee stock option.  Better, you only pay capital gains taxes and if your option goes to zero you can claim a capital loss.

Let’s take my favorite large cap oil company trading currently around $40 per share.  Tomorrow is the start of a new oil boom and 2 years from now in 2019, oil trades at $70 per barrel. What would that CNQ option be worth? Assuming operating costs don’t go up and neither do drilling costs go up (keep on dreaming), every dollar in oil price increase is a dollar profit.  So say the company earns currently $4 per share and produces just as many barrels of oil per day as there are shares then the earnings per share at $70 per barrel of oil would be say $25 dollar more or $29. The market for oil shares is currently depressed but you can bet that people will pay more than the current stock valuation if oil is $70 per barrel.  
First of all, the corporate profit has gone up from $4 per share to $29 that is more than seven fold. So forgetting about multiple expansion, CNQ stock could trade as high as 7 times $40 or $280 per share. You know, an employee with 2000 stock options would have made 2000 * (280-40) = $480,000 But what if you owned 2000 call options with a strike price of $40?  Yes, you also would have made $480,000.  The difference is that the employee’s stock option was paid out of his or her salary while you bought it in the market.  With many gurus thinking that oil will never go up, you may be able to buy 2000 call options expiring in two years for around $3000.  The good news is that if the employee gets laid off before her options expire, they are worth zilch. You only lose those options when you sell them!

Stock options are for bull markets, if an employee gets options during a bear market they are worth nothing. The loss is not even tax deductible!  If you really want to gain like an employee then you have to buy call options with an expiry date as far out as you dare.  And sell those options when you feel you have made enough profits.  The catch for both you and the employee is the question when that bull market ends – oil and gas is highly cyclical so sell all or better part of your options when you have made the profits that makes you feel happy. If you can’t sleep at night because you fear you might lose these profits then sell enough so that you can again sleep at night.
Now do you still want to work for that tech company or that oil or gold mining company?  Or would you rather buy some call options and do whatever you like doing best?

NOTE: CNQ has a lot more shares outstanding (1.2 billion) than it produces barrels of oil per day. So my numbers are bogus. But, I hope you get the idea.

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