What Is a Cashless Exercise How It Works with Stock Options

Cashless exercise, also known as "same-day sale," is when employees use a short-term loan provided by a brokerage firm to exercise their stock options. The proceeds from the options are then used to repay the loan. It is similar to buying shares on margin.

Key takeaways:

– Cashless exercise transactions involve using a broker.

– It allows employees to exercise options without upfront purchase of shares.

– Cashless exercises are popular among employees of publicly traded corporations and can receive favorable tax treatment.

Cashless exercise transactions are made possible by brokers who lend employees money to exercise their options. This method is commonly used by employees who participate in employee stock option plans (ESOPs), especially in publicly traded companies with greater liquidity. Private companies may achieve similar results through other mechanisms, such as issuing promissory notes.

Example of a cashless exercise:

– Emma works for XYZ Corporation and has accumulated stock options.

– She could purchase 5,000 shares of XYZ stock at $20 per share.

– The market price is currently $25 per share.

– Emma could make a theoretical profit of $25,000 by buying and immediately selling the shares.

– However, she doesn’t have the $100,000 required to purchase the initial shares, along with taxes and brokerage fees.

– Her employer offers a cashless exercise plan.

– Emma is given a short-term loan of $100,000 by a brokerage firm.

– She exercises her options, buys $5,000 worth of stock, and immediately sells it for $125,000.

– Emma repays the loan and transaction costs with the cash from the sale.

– Favorable tax treatment applies if certain conditions are met.

The broker handles the transaction on behalf of Emma, and the money from the sale arrives after repayments.