If you’re one of the fortunate people who has built wealth through a concentrated employer stock position… Congratulations! You’ve likely been part of an incredible team of highly talented individuals and seen the company grow to what it is today. However, “trees don’t grow to the sky,” meaning it’s not reasonable to expect this outperformance (relative to the broader market) to last forever.  

At some point, you may ask: 

• Is too much of personal wealth held in my employer’s stock?
• How much stock is too much? (more on this here)
• How do I effectively reduce my employer stock position? 

Sell Your Shares

The easiest way to de-risk your concentrated stock position is to simply sell your shares. However, there are often tax consequences associated with selling large positions of stock. Capital gains tax must be paid for sold positions that have increased in value. Short term gains apply to shares held for less than 1 year. Long term gains (typically taxed at lower rates) apply to shares held longer than 1 year. 

Additionally, selling your shares at one specific point in time subjects you to the market price at the moment of sale. Some individuals prefer to receive an average sales price.  One solution is to systematically phase-out of the position by selling your shares over a specific period of time. For example: if you own 1000 shares, you could sell 100 shares each week over a 10-week period. This would allow you to realize an average sale prices over the 10-week term. 

Use Options to Hedge Your Position

A stock option is a contract to purchase or sell stock at a specific price at a future time. You can use options strategies to reduce the risk of your concentrated stock position without selling your shares. 

Put Options

A long put option increases in value when the stock price of the underlying company falls. Put options can act as insurance in the event the stock price drops substantially. However, insurance isn’t free — you’ll need to pay the option premium (the cost of the option). You must determine an appropriate position size, strike price, and expiration date for your put options based on how much risk you’d like to eliminate.

Collars

In addition to buying a put option, you could also sell a call option simultaneously. Selling (shorting) a call is a promise to sell your shares at a specific price in the future. If the price goes up, you must sell your shares at the contract’s exercise price. For example: If you sell a call with an exercise price of $100, and the stock goes up to $120, you must sell your shares for $100/share. The benefit of selling calls is that you collect the option premium. In our example, if the stock price drops to $80 at option expiration, you receive the option premium and do not need to sell your shares. With short calls, you are giving up a portion of the price growth in exchange for receiving income from the option premiums. You act as the insurer in this scenario.  

When the cost of your long put is covered by the premiums generated from your short call, this is known as a cashless collar (or zero-premium collar). A cashless collar keeps the value of your employer equity position within a specific range. For example, it could allow the value of your position to float between +20% and -20% of today’s market value.  

When it comes to collars, you must be careful about a sneaky IRS rule known as “constructive sale” (Section 1259 of the Internal Revenue Code). If you use options to eliminate most of the risk associated with your concentrated stock position, the IRS will categorize this as a stock sale (you effectively sold your shares by eliminating value changes from stock price movements). In this case, you would need to pay all capital gains taxes due as if the shares were sold on that date. Many tax experts believe that a collar should have at least a 15% band around the current trading price to prevent triggering a constructive sale. 

Conclusion

The strategies listed here are only a few of the strategies available for reducing concentrated stock positions (there are several others). 

There is a decent amount of complexity associated with reducing your employer stock position. Questions that often come up:

• How much should I sell?
• How do I minimize the tax impact?
• Which strategy should I use?
• What should I do with the sales proceeds? 

Consider speaking with a qualified financial professional to help you navigate this process.