Getting past the stock option blues

Then came the tech downturn, draining value out of former high-flying stocks and leaving option-holding employees--especially those who envisioned pocketing their paper gains for early retirement or buying second homes--feeling like suckers. Even worse, some options turned into ugly liabilities, costing hundreds of thousands of dollars in unintended taxes.

But Bill Briggs says options don't deserve their bad rap. In fact, he says, workers who dismiss options as worthless relics of the Internet bubble are making a costly miscalculation. Options, he says, deserve a second chance.

Briggs is CEO of Net Worth Strategies, a Bend, Ore.-based company that makes software for financial planners. The company, which has 900 clients including Deloitte & Touche, American Express and U.S. Trust, on Aug. 1 announced a deal to license its flagship StockOpter software for financial counseling to Ernst & Young and OppenheimerFunds.

Briggs talked to CNET News.com about how options work, how they sometimes sabotage portfolios, and why he ranks some chief financial officers as hypocrites.

Q: Why bother talking about stock options at all? Aren't they all worthless? We don't think that's true at all. It's true in certain segments, like dot-com. But there are a lot of companies that issued options back in the mid-1990s. Those stocks may have taken a wild ride, but the values are still above 1995.

What, if anything, did the downturn teach us?
What happened with the market adjustment is that it got everybody's attention. Prior to the adjustment, people had a great tendency to procrastinate. They didn't sell their options unless they needed a new car or house. They would just sit on the option on the belief that company stock was going to appreciate at 10 or 15 percent a year. If you have a really high tolerance for risk, that's a good option. The problem, of course, is that not all but a fairly large percentage of option holders have a very concentrated position in that stock, so they're taking a big risk.

The adjustment has made us realize that options are risky. They're not a sure thing. Hopefully more people are taking action today that would have been had that adjustment occurred. The realization is a good thing.

It seems like you're saying that option holders should sell immediately upon vesting. Is it good advice to sell your options as soon as they vest, simply for the sake of diversification?
My advice would be to carefully consider the subject of concentrated stock; most people don't. For most people, unless they're riverboat gamblers, they should be implementing a systematic diversification strategy. You exercise and sell the shares after they vest, take the proceeds and invest them in a well-constructed portfolio. Liquidate your position. I'm sure the CFOs of corporations around the world don't like me saying that. But they know that that's exactly what they do.

What about all the Microsoft millionaires who got rich simply because they had options in a single company and had a supremely concentrated portfolio?
There were relatively few cases of getting really rich off of holding onto options. You're almost always better off diversifying. Our new software has run simulations over the past 15 years, doing a history of stock option performance at IBM, Xerox, Apple, Microsoft, Intel and others. If your company behaved as Microsoft behaved, yeah, you're better off holding on until the last minute. But most of us don't work at Microsoft. And I'd also argue that Microsoft's next 15 years are going to look a lot more like IBM's rather than Microsoft's over the previous 15 years. So diversification is really the appropriate strategy for the vast majority of options holders.

The idea of diversification is logical, but don't most people hold onto their options as a sign of faith in the company that they work for? Don't most people perceive options differently than they perceive their portfolio of stocks and bonds, which are purely investments?
You're right. And that's the first thing people need to get over. Do you care more about company loyalty than sending your kids to college or providing for your retirement? The executives of the company have a diversification plan. Why shouldn't the employees as well? It seems only rational to me that one takes that money off the table. If it's only 10 percent of your net wealth, fine--look at it as casino money. But if you had $500,000 in the bank, would you spend it all on stock on your company? Probably most people wouldn't. Most people don't see options as an investment. They see options as free--something the company just gave out, out of the goodness of its heart. But they're really money. Treat it that way.

Why do so many people see options as a sign of loyalty, not an investment?
Stock options always have been issued by corporations to achieve just that end--loyalty. That's why I issue them--to create excitement among employees and give them a stake in the company's financial success. It's why you have vesting schedules over time and why valued employees are continually issued stock options that vest over four years. They'll have a continued stake in the company.

But this idea that they're simply about loyalty is not good. And even the idea of holding onto them to try to sell at the peak--that's not a good idea, unless you're an expert. If you get emotional and try to time the market, you're going to lose.

You're a chairman and CEO who gives options to your best workers. Yet you're also a finance expert who preaches diversification. Is this hypocritical?
(Laughs.) It's not a conflict for me. I care a lot about our employees, and I think most CEOs do. If my employees asked for my advice, I'd tell them they needed to diversify. Then, if the person has a high level of contribution to the company, we'll talk about more options.

In the late 1990s, it was common for companies to issue stock options throughout all ranks of the company--even to secretaries and janitors, who often have little ability to sway the stock price. Did companies give out too many options? Will they scale back?
I'd argue no. It seems to me it's become a currency of employment. In places like the Silicon Valley, it's risen to the level of expectation. I don't think we're going to see them fading away. I want everybody in my company to feel they're part of the team, whether they have a huge influence on the stock price or a small influence. Our administrative people who answer the phone are our first face to the customer--maybe the most important face.

What about the many, many people sitting on underwater options. Should they presume the options won't buy them an early retirement or ski chalet in Aspen?
It's important to plan for underwater shares: They're not altogether worthless. If I have a $10 strike price and eight years to vest, and the stock is now $5, that share has value. The reason? There is a likelihood that the stock will eventually pass $10 in eight years. That's a long time. If the stock is now at 35 cents and the company's going to fold, that could be a problem. But if it's just underwater, that's nothing to worry about.
Employers should be doing a better job of educating employees on what options are all about...The fact that we're going through a bear market now is relatively meaningless when it comes to options. It's a short-term market phenomenon. Options are a long-term incentive.

What's your most important advice to people when it comes to stock options?
Spend a couple hundred bucks--it shouldn't be any more than that--and hire a financial counselor to educate you about options. It's an incredibly complicated issue.

Can't people simply buy your software, which is now used mainly by CPAs and financial planners?
We've had a lot of consumers who have looked at it; I'm not aware of a single one who has bought it. The program is so complicated because the underlying rules are so complicated. So I guess it's had its desired effect: Consumers download it and say, "Whoa, that's really complicated." Then they run to their CPAs. I'd love to tell people to buy the software. But the fact is that this isn't a good do-it-yourself project. It's of similar complexity as estate planning. It requires knowledge and analysis beyond what most people have time to learn.