Understanding Equity Compensation: StockOpter University Glossary

A

Alternative Minimum Tax (AMT)

A parallel tax system designed to capture some of the taxes that would have been paid without tax-advantaged investments such as incentive stock options. To compute the AMT, several items of income and deduction are added to or subtracted from your adjusted gross income that was computed under the regular tax system. Such items may include taxes that were deducted on schedule A, the in-the-money value of incentive stock options (ISO) that were exercised and held during the year, the difference between the regular gain and AMT gain on previously exercised ISO shares that were sold during the year, and many other adjustments that are listed on Form 6251 and its instructions. Then the AMT exemption amount is computed and subtracted. The resulting figure is then your alternative minimum taxable income, which is then taxed at 26% and then 28% if it is high enough to graduate to the higher bracket. If the resulting amount is higher than your tax computed under the regular tax, then the AMT is paid.

Asset Allocation

The division of a portfolio among various types of investments such as bonds, stocks and cash, each with its own risk/ reward characteristics. In respect to equity compensation, asset allocation refers to the division between the individual’s value of their diversified portfolio (VDP) and their holdings in company stock and and options (i.e. Vested Options, Unvested Options, Restricted Stock and Owned Shares). See “Concentration” in the StockOpter glossary for more information.

B

Black Scholes Value

Represents the full value of a stock option. Black Scholes Value = In-the-Money (ITM) Value + Time Value. It is calculated using the Black Scholes formula using assumptions such as: ITM Value, Time to Expiration, Stock Volatility, Risk Free Rate and Dividend Rate.

C

Capital Gains Tax

The tax paid on capital gains (when the sale price of an asset is greater than the price paid for it). Long-term capital gains tax refers to investments held for over 12 months before selling them.

Concentration

As it pertains to holding company stock and options, concentration refers to the division of one’s holdings such as vested and unvested options, restricted stock and company shares held outright or owned compared to the total value of their other investments. This comparison shows the degree of concentration in all company stock and options and is therefore an indicator of risk and a decision trigger for diversification.

Cashless Exercise

An option exercise method where the holder borrows money from the sponsoring broker to execute the trade. The optionee then has all of the shares sold simultaneously, paying off the temporary loan and receiving the net cash proceeds. Also called a same day sale.

Cash Purchase & Hold Exercise

An options exercise method where the employee uses cash to execute the purchase of the underlying shares of an option. Future capital appreciation will be taxable at the more favorable capital gains tax rates.

Cost Basis

Refers to the price an investor pays to acquire shares of a stock (e.g. exercising or market purchases), plus any income recognized due to the acquisition of such stocks.

D

Disposition

Refers to the employee “disposing” of stock by selling, exchanging, or gifting it.

Disqualifying Disposition

The act of selling the underlying stock associated with an ISO exercise before the 1 and 2 year holding period requirements. The sale is treated as ordinary income for taxation purposes.

Dividend

This is the annual per share dividend paid by the company. This value is used in the Black Scholes calculation, but it is not a required assumption.

E

Exercise

To purchase employer shares granted by a stock option. The purchase price of the shares is set by the exercise, grant or strike price of the option.

Expiration Date

The last date on which a stock option can be exercised.

F

Fair Market Value(FMV)

Also referred as the current stock price. It is used to calculate the value company stock and options.

G

Grant Number

The company’s identifying number for each grant of company stock or options.

Grant Date

The date when the employer has taken all the actions necessary to grant an employee company stock or options.

Grant Price

Also known as the “Exercise Price” or “Strike Price.” It is the price at which an employee can exercise a stock option, once vested. It also represents the cost of shares under a restricted stock award when the restrictions are lifted (this is generally zero).

Grant Type

Refers to the different types of equity compensation grants that are issued. In general, there are two basic types of grants: “Option Grants” and “Share Grants”. Stock option grants include: Incentive Stock Options (ISOs), Non Qualified Stock Options (NQSOs), Stock Appreciation Rights (SARs) and Performance Stock Options (PSOs). Option grants have a grant date, expiration date, exercise price and a vesting schedule based on dates or performance criteria. Share grants include: Restricted Share Awards (RSAs), Restricted Stock Units (RSUs) and Performance Stock Grants (PSGs). These grants have a grant date and vesting schedule that is either time or performance based. Share grants generally do not expire and have no exercise price.

See specific entries for more information on specific grant types.

I

Incentive Stock Option (ISO)

An option that meets certain rules for preferential tax treatment. If the conditions are met, the holder is not required to pay ordinary income tax upon exercise. ISOs however are subject to AMT.

In-the-Money (ITM) Value

The current value of an option calculated by the Fair Market Value (FMV) – the grant price X the number of shares.

Insight Ratio

A metric calculated by dividing the Time Value of an option by the Black Scholes or Full Value of it. The resulting percentage represents the remaining theoretic potential of the grant which can be used as a determinant for determining whether to hold or to exercise the option. For example, an Insight Ratio of 10% means that 90% of the option’s value is In-the-Money value which is at risk if the option is held. Low Insight Ratios (<20%) represent high risk and low potential because most of the theoretic potential has been realized. Conversely, an Insight Ratio of 70% means that 70% of it’s value is Time Value which won’t be realized if it is exercised at this point. High Insight Ratios (>50%) represent low risk and high potential in holding because there is a lot of Time Value to be realized. Determining the optimal Insight Ratio for exercising and selling is a function of the participant’s personal situation including risk tolerance, proximity to retirement and cash flow needs.

K

L

M

Monitoring Alert Trigger

A StockOpter.com function that sends users and/or participants email alerts when the designated decision criteria is “Triggered” by the closing stock price (i.e. grants with Insight Ratios < 15%). Triggers include: Insight & VaR Ratios, Stock Price, Financial Goal Attainment and Concentration Percentage. For more information about setting Monitoring Alert Triggers see the help text on the “Participants to Monitor” page under the “Monitoring” menu.

N

Non-qualified Stock Options (NQSO)

Options that are not eligible to receive preferential tax treatment. Recipient is subject to ordinary income taxes upon exercise, as well as being subject to payroll taxes and withholding obligations on the date of exercise.

O

P

Q

Qualified Sale

This refers to the sale of ISOs that meets the holding requirements to receive favorable capital gains treatment (2 years from date grant and 1 year from date of exercise).

R

Re-Pricing

When a company resets the grant price of stock options that have already been granted. NOTE: due to FAS 123r, there are expensing issues associated with re-pricing.

Restricted Stock Award

A Grant of employer stock at no cost (or a substantial discount) that is subject to a vesting schedule. These awards include restricted stock and restricted stock units (RSUs).

Risk Free Rate of Return

The Risk Free Rate of return (RFR) is used in the Black Scholes calculation. It is generally derived from US Treasury yield curve. The RFR used by the company to expense their stock options can be found in their 10-k.

S

Sell-to-Cover Exercise

The exercise of an option with the simultaneous sale of enough of the exercised shares to cover the exercise price, taxes, and transaction costs.

Stock Option

A grant of the right to purchase company stock in the future at a fixed (grant) price.

Stock Split

When a company takes their current shares of stock and divides them into more shares (ex: 2 shares for each 1 now issued). Stock splits affect grants of company stock and options.

StockOpter Pro

Strategy modeling software that allows users to model multiple equity compensation exercise & sell strategies to facilitate client decisions that are tax and cash flow efficient. “Pro” is designed to significantly reduce the time required to illustrate the after-tax effects of alternative diversification strategies. It handles any number of ISOs, NQs, and Restricted Grants, develops complex strategies for after-tax cash-flow or diversification goals that are “up to the AMT limit”, its output compares tax and cash-flow results of different strategies, and you can use it to compare strategies by applying price indices to the company stock and the alternative investment.

StockOpter Insight

A discontinued Excel based program that assists advisors to build relationships and help clients make timely and prudent diversification decisions. StockOpter Insight generates “Personal Equity Compensation Profile” reports and provides limited monitoring capabilities. NOTE: StockOpter Insight was replaced by StockOpter.com effective December 1, 2008.

StockOpter.com

A web-based application designed to be used by stock plan participants, plan sponsors and financial advisors to provide equity compensation education and decision support. StockOpter.com replaces StockOpter Insight effective December 1, 2008. In addition to Insight’s report generation capabilities, StockOpter.com provides “What-If” Dashboards and monitoring alerts.

T

U

Underwater (Out-of-the-money)

Refers to options when the stock’s current market price is below the grant price on the option. Example: an option priced at $20 when the stock is trading at $15. NOTE: underwater options may have time value.

V

Vested

The portion of an employee’s options that are eligible to be exercised.

Vesting Date

The date that a set of options can be exercised.

Vesting Period

The period of time required before any options can be exercised by employees.

Cliff Vesting

An all-or-none vesting option where the employee’s options become vested on one date. Until that date, the options are considered 0% vested.

Performance Vesting

Vesting that is tied to predetermined goals set by the company, typically related to certain earnings or revenue targets.

Straight Vesting

When the percentage of options exercisable each year is the same (i.e. 25% for 4 years).

Value at Risk (VaR)

VaR is a statistical method of valuing risk developed by banks to evaluate the overnight risk inherent in their portfolios. It is based on the concept of lognormal distribution. VaR measures how large a loss might be, when incurred due to market risk over some time frame and at some confidence level. In reference to company stock and options, VaR is used by StockOpter.com to measure the risk inherent in vested options and held stock.

VaR Ratio

A metric calculated by dividing Time Value of an option by the VaR (Value at Risk). It is a comparison of the theoretic potential (Time Value) to the theoretic risk of the option at the current time. The lower the TV/VaR percentage, the more compelling is the argument for diversifying the option (exercising and selling). For example, a ratio of 25% means that the theoretic risk is 4 times as large at the theoretic potential. Please note, while the value of this ratio could be infinitely large, a 1,000% ceiling has been asserted.

Volatility

Stock Price Volatility is the annualized standard deviation of the changes in stock price. This value is used in the Black Scholes and VaR calculations. For publicly traded companies it can be found in the annual report (10-K) which can be found at finance.yahoo.com (SEC Filings) or at www.ivolatility.com. For private companies it can be estimated from publicly traded peers. For more info see the BSV Concept Tutorial in the Dashboard.

W

X

Y

Z