What to do with vested stock options

Unlike RSUs, which convert to shares you own the moment they vest, a vested option is just the right to buy shares at a fixed price, and nothing happens until you decide to exercise it. 

What to do with vested stock options depends on the type of option you hold, your tax situation, and how much risk you’re willing to carry in one company’s stock.

Vested stock options vs. RSUs

It’s easy to lump vested options in with vested RSUs, but the tax mechanics are different. An RSU converts to stock you own outright at vest, and you owe ordinary income tax on its value whether you sell or hold. 

A stock option gives you the right to buy shares at a fixed strike price instead. Exercising it converts that right into actual shares, and depending on whether you hold incentive stock options (ISOs) or non-qualified stock options (NSOs), that exercise can trigger very different tax consequences before you’ve sold anything at all.

Your choices once options vest

Four things can happen once your options vest, and each comes with its own tax timing.

Exercise and hold. Buy the shares at the strike price and keep them, taking on the stock’s future risk and reward. 

This is where the tax bill shows up soonest: exercising an ISO can trigger the alternative minimum tax (AMT) on the spread between your strike price and the current value, even though you haven’t sold anything and have no cash from the transaction to pay it with. 

Exercising an NSO is simpler but not necessarily gentler. The same spread is taxed as ordinary income at exercise, similar to how RSU income is taxed at vest. Either way, once you’re holding the shares, any further appreciation is taxed as a capital gain whenever you eventually sell.

Exercise and sell immediately. A “cashless exercise” because you buy and sell in the same transaction, converting the spread straight to cash. 

For ISOs specifically, selling in the same year you exercise is what’s called a disqualifying disposition. The IRS treats the spread as ordinary income under the regular tax system, and because that income is already taxed there, no separate AMT adjustment applies. 

NSOs are taxed as ordinary income on the spread at exercise either way, whether you hold or sell immediately. In both cases, since you’re not holding the shares afterward, there’s no separate capital-gains step to think about later.

Wait and exercise later. Vesting isn’t a deadline. You can hold off, as long as you exercise before the options expire. None of the tax consequences above apply until you actually do.

If you leave the company, the clock changes for ISOs. You have 90 days from your last day to exercise and keep ISO tax treatment. That’s federal law (IRC Section 422(a)(2)), not just a company policy.

Some employers now give you longer than that to actually exercise. But if you exercise after the 90-day mark, the option automatically becomes an NSO for tax purposes, no matter what the plan allows. You lose the ISO treatment described above and pay tax as if it were an NSO instead.

NSOs don’t have this rule. They just follow whatever deadline your plan sets.

Let them lapse. If the strike price is above the current value, or exercising no longer makes sense, you can walk away with no tax consequence at all, since nothing was ever exercised.

Holding can lead to concentration risk

If you exercise and hold, and your position grows large enough, you run into the same problem RSU holders face: a big share of your net worth riding on one company’s stock, and you’re holding a concentrated position. 

Selling outright is the direct fix, but it means paying capital gains tax on top of whatever you already owed at exercise. Exchange funds built for concentrated stock positions allow you to reduce this kind of risk without a sale. Instead of selling, you exchange the shares for a diversified stake. 

Glidepath is an exchange fund with a $100,000 minimum contribution and no fee charged to members. If exercising has left you sitting on a concentrated position with significant unrealized gains, see whether an exchange fund fits your situation.

Weighing your options yourself

There’s no single right path here, and no advisor can make the decision risk-free for you, but you can work through it methodically:

• How much cash do you have to exercise and cover any tax due, especially AMT on ISOs? Would exercising strain your finances?
  
• How much of your net worth would the resulting shares represent? If it’s a small slice, holding is a lower-stakes bet. If it would make up a large share, you could increase concentration risk.
  
• How much time is left before your options expire? Waiting costs you nothing if you have years left. It can force a rushed decision if you don’t.
  
• What’s your appetite for concentration risk, separate from your appetite for this particular company’s stock? Believing in the company and being comfortable with the position size are two different questions.

Running through these four questions won’t hand you an answer, but it will tell you which factor is actually driving your decision, which is usually the harder part to see clearly on your own.

Realized gains but don’t want the concentration risk? See if you qualify for the Glidepath exchange fund.

FAQ

What should I do with my vested stock options?

It depends on the type of option, your cash on hand for exercise, any tax due, and how concentrated the resulting position would leave you. There’s no single right answer, but working through those factors will point you toward the one that fits your situation.

Do I have to exercise my stock options once they vest?

No. Vesting only gives you the right to exercise, not an obligation. You can wait, as long as you exercise before the options expire. 

If you leave the company, watch the calendar closely: ISOs must be exercised within 90 days of termination to keep their ISO tax treatment, even if your plan technically gives you longer. NSOs follow whatever window your plan sets, without that same statutory deadline.

What happens if I exercise and end up with too much company stock?

You’re in the same position as anyone carrying single stock risk. Selling outright is the direct fix. An exchange fund is worth considering if you want to diversify without an immediate tax bill.

Vested stock options put a real decision in your hands, one with consequences that show up on your tax return whether or not you act. Working through the cash, tax, and concentration questions above, rather than treating exercise as a foregone conclusion, is what actually turns vesting into a decision you made rather than one that happened to you.