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Strategies for Restricted Stock Units

| April 01, 2014
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A restricted stock unit (RSU) is a form of executive compensation valued the same as the company's stock. There are 3 important dates associated with an RSU: Grant, vest, and sale. 


Grant: When RSU's are granted, no shares are issued or owned and there are no tax consequences.


Vest: Once shares vest, either by the passage of time or by attaining certain company or individual goals, shares of stock or cash equivalent are distributed to the executive.  If the executive does not meet the goals or leaves prior to vesting, the award is generally forfeited.  The value of the award is generally taxed as income in the year it vests unless the plan allows the executive to defer receipt of the cash or shares to a later year.  From a tax standpoint, this is similar to receiving a cash bonus.


Sale: Once shares have vested, the executive may have the option of holding the shares until he/she decides to sell. The holding period begins at the vesting date and ends at the date of sale for purposes of determining whether a short term or long term capital gain or loss has occurred.


For many clients, once shares have vested, significant risk and significant opportunity exist by holding shares. Shares may be a concentrated holding meaning they are valued at more than 10% of the executive's total investable assets. Should share prices continue to rise, such holdings can lead to an increase in wealth. However, should share prices fall, not only will the executive lose investment value, but taxes have already been realized on the higher vested valuation. 


So how can the executive protect themselves against a declining share price?


One obvious strategy is to sell some or all of the shares of stock upon vesting. Since the value of the vested shares is included in ordinary income, selling right away will have minimal capital gains implications. Sale proceeds could be reinvested in more diversified investments which may lower risk. However, any upside potential to holding the stock is lost. Perhaps selling a portion of the shares each year over several years will gradually reduce company risk and provide some upside potential. 


A second strategy is to put a trailing stop loss order on the shares. Should the share price fall to the specified stop loss price, a sell order will automatically be triggered.  Stop loss orders can be placed at nearly any price below the current price. The closer to the current price, the more likely it will be triggered. For example, a stock selling for $60 per share currently could have a trailing stop loss sell order placed tightly at $58 per share.  Should the stock price fall below $58, the order becomes a market order and shares will sell at the next available price.  Setting a slightly looser stop at $55 per share will allow a little more fluctuation before the sell is triggered, and setting a loose stop at $48 allows a 20% fall before the sell is triggered.  This is a low cost way of protecting against a dramatic drop of share price, but if prices fall just enough to trigger a sale and then appreciate from there, the executive will have stopped out losing the potential for gains down the road.


A third strategy is to write covered calls on the shares. This provides minimal downside protection however. With covered calls, the shareholder is obligating themselves to sell at a stated price and collecting a premium for doing so. In our earlier example, if shares are trading at $60, the shareholder could sell a covered call on those shares obligating them to sell at $62.  If shares are trading under $62 by expiration of the call, the shareholder keeps the shares and the premium for selling the call option.  The longer the time period, the higher the premium received by the call seller.  Should share prices move above $62, the shareholder will be obligated to sell at $62 thus limiting upside potential.  Also, should shares fall in value, the call seller will retain the shares and the premium but if shares fall dramatically, there is little downside protection with this strategy.



A fourth strategy is to buy puts on the shares. Buying put options provides downside protection at a cost, similar to buying insurance on the stock.  If the shareholder owns a stock at $60 per share and buys puts on those shares at $60, the put buyer is giving themselves the right to sell shares at $60.  Should the share price fall to $50, the put buyer may buy shares in the market at $50 and exercise their put option to sell at $60 pocketing a $10 gain minus the cost of the premium to buy the put. In our example of a stock that falls from $60 to $50, the put buyer would lose $10 per share on the stock, but would gain $10 per share on the puts effectively insuring against a loss. However, the cost of buying puts can be expensive.



A final strategy is a collar which combines strategy 3 and strategy 4 above. By simultaneously selling a covered call and buying a put on the underlying shares, the executive can offset some of the cost of buying the puts with the premiums received for selling the calls. This strategy provides protection against a loss but limits upside potential. By adjusting the exercise prices, the executive can give the stock some room to move up and down but essentially provide a floor and a ceiling. For a stock selling at $60 per share, perhaps buying puts at $55 and selling calls at $62 provides some room for the share price to fluctuate.  If share value falls below $55, the puts will be in the money offsetting a loss.  If shares increase past $62, the shareholder will obligate themselves to sell at $62.



In summary, there are several strategies available for executives with restricted stock units once shares vest.  Each strategy has pros and cons. By meeting with a certified financial planner(tm) the executive and planner can formulate goals, take into account hopes and concerns, and formulate strategies to help the executive be successful with share compensation.


Denton Olde, CFP®, M.S.

Financial Advisor   

Olde Wealth Management, L.L.C. / Cetera Advisors, member SIPC

Denton Olde nor Cetera Advisors LLC provide tax advice. You may wish to

consult your tax professional regarding your individual circumstances.

Options are not suitable for all investors


 All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful


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