To any informed trader of stock options, it is a sin to prematurely

exercise your listed call stock options.

This is because upon exercise, all remaining time premium is

forfeited to the writer of the calls.

It is a mortal sin to prematurely exercise employee stock

options because upon exercise you similarly lose all

remaining time premium back to the writer, which is

the employer. You also will have an immediate tax liability

in the case of non-qualified ESOs and in the case of qualified

ESOs upon sale of the stock.

The tax is ordinary compensation income on the intrinsic

value of the NQESOs at the date of exercise.

If the ESOs are qualified, then the income will be long

term capital gain on the date of sale of the stock

(assuming that the stock is held long enough).

So why do advisors predominantly tell holders of

ESOs to make premature exercises?

There are several reasons:

1. Some believe that premature exercises is the right

thing to do to reduce risk and take profits. They want

you to diversify the net residual amounts (which may be

less that 40% of the "fair value" of the options) into

mutual funds where they make fees or commissions.

It's a simple strategy. No rocket science required.

The advisors are considered in good regard by the

employer/company. Premature exercises benefit the

company because the forfeited time premium goes to

the company and reduces the company's costs. It's as

if the company is the writer of listed calls.

The company also gets early tax deductions upon

premature exercises. The company also gets an

immediate infusion of cash when the exercise of the

options is made (unless the company purchases the stock

in the open market to reduce dilution - which they seldom do).

The company would receive the cash later, the tax

deduction later and receive no forfeited time premium

if the exercises were done timely.

2. These advisors know little about hedging with

exchange traded options and therefore are afraid to

venture into that arena. Tax lawyers, accountants and

financial advisors call themselves options advisors and

experts when they have never traded or managed option

portfolios in their lives.

3. These advisors who discourage hedging, give a

number of false reasons. Those are:

a) The company prohibits hedging.

b) Tax laws makes hedging with listed options very difficult.

c) Secton16 b) and c) of the Securities act of 1934 and SEC Rule

10b 5) prohibit or discourage hedging for executives.

d) Transaction costs and margin requirements effectively

prohibit hedging.

e) Hedging gives the appearance of being negative on

the stock's prospects.

f) Hedging defeats the purpose of the options grant

(i.e. creating an alignment of the interests with those

of the employer).

None of these reasons are valid. Even if every employee

is prohibited or discouraged from using listed options on

the employer stock to hedge their ESOs, there is never a

prohibition against selling calls against the competitor

stock or other positively correlated stock. The results

could even be superior to hedging with options against

the employer's common stock.

Selling calls on correlated stock allows the employee

to pick and choose on which company he wishes to sell

calls and the exact timing of the sales.

Ask your advisor why he does not recommend the use

of listed options and see what he says.

He will probably change the subject.

John Olagues

olagues@hotmail.com