This will work if you're paid in the stock of a big company, which will have a market in its options as well. But then why not just short the things if you don't want to have the stock?
It doesn't work for non-listed startups. Lots of idiosyncratic risk, and no liquid market in the shares.
The cost of borrowing stock to short it is often higher than the corresponding option premiums. You also generally need less on deposit to execute the options strategy (that is, your value at risk will be lower, as will your margin interest cost).
I could retort with an equally glib "why don't employers just pay their employees in cash?"
Well, they're trying to pay you in stocks to make you feel like you need to work harder. (I don't get what you are retorting to?) If you work for a public company, you can short circuit this by removing the risk (via options or shorting) and effectively taking the money immediately. I suppose they might have something in the contract to stop this from happening, but I don't know what the standard practice is.
Most companies that are trying to pay you through equity are doing so not (just) to make you feel like you need to work harder--which is a joke for the obvious reasons--but, and this is no less important, so they don't have to pay you in cash. Cash is expensive and in the present. Stock is a question mark nobody has to care about for years.
Except that cash has never in all of recorded human history been cheaper. So the "cash is expensive" argument doesn't really hold water. Put another way, something else must explain why equity compensation is more common now than in the past, especially in light of how cheap cash is.
In this case, cash is still more expensive because they have to have the cash, and they have to have it now. It costs almost nothing to issue the tiny percentage of stock you'd receive, and they don't have to worry about actually paying anything for a while, if ever.
I have a small disagreement with your first point. It can happen, and even more often there are no shares to borrow from your broker at all, but it's not "often" that way. Options trades are not brokered between two clients the way equities are. You're trading with a market maker, and that's true whether you're buying to open or selling to open. When a market maker sells you a put, the first thing he does is offload that risk by shorting the stock. He's not paid to take directional risk. And that put premium needs to cover the carrying cost of that short position, in addition to things like implied volatility, time value, etc.
You are right that you get leverage with options, but there is no free lunch.
> This will work if you're paid in the stock of a big company
If by "this will work" you mean you will likely have the SEC, IRS, the company's own litigation department, and perhaps the FBI filing various civl and criminal charges against you, then yes it will work.
As "prostoalex" stated earlier, this is insider trading. Even if the person doing it thinks it isn't, it will be up to them and their lawyer to prove otherwise (a.k.a. "the defendant"). And that kind of proof don't come cheap (think $200,000+ USD depending on how pissed off the employer is).
Many if not most publicly-traded companies explicitly prohibit their employees from hedging out their risk in this fashion. Check the fine print of your employee handbook before doing it. And if you are a section 16 employee, you should already know that you are almost certainly prohibited from doing it.
What, did you think you were the first to think of this?
Only as gray as the definition of "material nonpublic information", which has a much stricter legal definition than the plain-language meaning would imply. Always consult qualified counsel, of course. But in general the best advice is not to accept equity as compensation for services. Anyone who cannot compensate you in cash is by definition desperate.
In a lot of big tech companies, stock is a big part of compensation. This is usually in the form of Restricted Stock Units (RSUs) [0], which are just stock which you receive at various vesting dates. I don't know why companies choose to pay compensation in this way (instead of cash). Maybe because it's easier to write the contract that way (an RSU grant is a contract) than to write the equivalent contract for cash compensation. I suspect there is no good reason at all for this.
But the important thing is that during salary negotiation, asking for everything in cash is not an option. So actually turning down equity based compensation (at least in this case, I'm not commenting on pre-IPO situations) is extremely bad advice. Equity should be discounted because of the risk, but RSUs are worth real money and should be treated as such.
I'm familiar with these instruments and with the custom.
It is not sufficient to discount them for business risk or interest rate risk or any of the other common risks; they must also be discounted for concentration. Unless you were born into a large trust fund or have already accumulated vast wealth (and expect to work for only a short time more), the discounted present value of your expected future salary is going to be your largest asset. That asset is substantially dependent on the business and market fortunes of your employer; therefore, any further exposure to those fortunes represents additional excess concentration. Even if your downside exposure is limited, as it is with RSUs and options, that exposure must be devalued if it represents excess concentration. For most people, the proper devaluation is going to be 100%. You already have too much exposure to your employer. You want to lay off that exposure any way you can (as the author understands), not add more by accepting equity in lieu of cash.
It's simply not correct that demanding cash is not an option. It's a business negotiation; anything is an option. You may not get all, or even any, of what you want, but categorically refusing to ask for it is seldom a winning strategy.
>For most people, the proper devaluation is going to be 100%.
The author argues, correctly, that exchanging stock for its current market value is a good deal. I agree (and I also agree with you that there is extra risk from having your own company's stock). But from none of this does it follow that we should discount stock units by 100%. That is like saying that an offer of $100 with 50/50 odds, would be worth 0, or would be worth zero if the coin toss was correlated with some life event.
I think the problem with your reasoning is that you are treating risk as a concept of independent importance, while it is really a derived concept, with the fundamental concept being the utility from a probabilistic cash flow.
>It's simply not correct that demanding cash is not an option. It's a business negotiation; anything is an option. You may not get all, or even any, of what you want, but categorically refusing to ask for it is seldom a winning strategy.
Having been involved in these negotiations and seen people's salaries and stock grants (through legitimate means), I can say that trying to get more base salary is really hard, and not worth the time. Even if you got more salary, it would come at the cost of so much less stock that it wouldn't be worth it.
The overall position is not short, though I don't know how much that matters in practice. Overall this is not about taking a bet against the company so I don't see an ethical problem with it, though again it could be in violation of agreements.
Even if hedging the risk directly is banned, you may be able to create a reasonable approximation by hedging shares of a near competitor. Apparently people in finance who get paid partly in options do this kind of thing all the time.
Also, how would you ever get caught if you just ignored what it said in the handbook?
> Also, how would you ever get caught if you just ignored what it said in the handbook?
At this point, I assume that everything you do is known to everyone. It's unfortunate, but it's also the sensible assumption. Even if the law would seem to prevent them from discovering your actions, there's no reason to believe that law will actually protect you. At the very least, they can almost always fire you without any reason at all, so even the slightest suspicion is sufficient. They don't need to prove it in criminal court.
So I've never actually seen one of these agreements, but supposing your stock is in an index, is it also forbidden to go short the index and long in stocks outside your sector?
(I expect transaction costs would nuke this idea, but I'm somewhat curious how sophisticated big company employee agreements are.)
That's not covered by my current company's policy (and I don't recall seeing it in any of the other ones), but if you entered into such an arrangement, it would be plainly obvious what your intent was, and the fact that you didn't technically violate the company's agreement wouldn't be an excuse for the company's compliance department nor for the SEC.
Short the index and long everything but your SECTOR is probably OK. That's just a bet against your sector. Short the index and long everything except your specific COMPANY is not going to be defensible. (In my policies, it's more straightforward to just short the sector directly, if such an instrument exists.)
I've worked in finance and for several publicly traded companies and have never been barred from trading stock in our competitors (other than if they were a takeover target or potential acquirer in active talks with us and that I knew about that, which is vanishingly rare).
I've never seen that. If you have, was there some list? It can be pretty hard to even define competitors, especially if your own businesses are far-reaching or fluid. I mean, if you work for GE, does that just mean you can't own stocks? Or a company like Google whose actual business is narrow but whose ambitions are unbounded? That would be pretty hard to defend.
I have had competitors explicitly listed in employment agreements with catch-alls ("this is not an exhaustive list") with respect to non-competes. Indexing is fine.
I've never seen that at all. There are trading ban windows, sure, but nothing against trading in stock or options outside of them. I am sure for sales / executive that is different,
I've seen this repeatedly. In specific instance, at my last company I was specifically prohibited against any hedging activities, even when I already owned the underlying position. This is quite common. The logic should be obvious: a hedge is at least partially a bet against the company's success.
The logic is not at all obvious. We are talking about large, publicly-traded corporations, and employees whose roles do not fall under section 16 guidelines. Their ability to influence the company's outcomes is somewhere between not material and nonexistent. Indeed, the law sees no reason to prohibit them from trading in their employers' securities. Why should they be prohibited from hedging their exposure? How are the shareholders harmed by this? It seems like an irrational response to a hypothetical fear, not sound logic. Especially since the only perfect hedge is found in a Japanese garden.
> Their ability to influence the company's outcomes
It's not the outcome, it's access to material information. Anyone who has access to sales or revenue information can come to reasonable conclusions in regards to underperforming/overperforming come earnings time, and trade on that information.
If the information were material, then trading would be illegal. We're assuming these are people who can legally trade; i.e., those without access to material nonpublic information.
> ... the prosecution will assume you had some insider info to trade on. The onus is on you to prove that you didn't.
If you want to tango with people that salivate at prosecuting people which profited from hedging while employed at the company which they hedged, I can only recommend against that course.
It's rare to work for a software company in software engineering capacity and not have access to such information. Even if you deliberately avoid it, business metrics get shared during all-hands of various levels, or displayed on giant screens. Formation of a new team that will work on a project X with a large partner Y is by itself material until it's public.
There are trading openings and you have to file a 10b5-1 stating your intended trading strategy. Otherwise SEC will assume insider trading, and the story rarely gets better from there.
This is an insider trading. Whenever you purchase equity/options on your employer outside of 10b5-1 program, the prosecution will assume you had some insider info to trade on. The onus is on you to prove that you didn't.
Before getting into the software industry, being paid in stock seemed like a no-brainer, because I looked at tech salaries and thought that you people were all making, at a baseline, well above what it costs to live a comfortable existence, so why wouldn't you play the odds a bit and try for a valuable payout when your stock options mature? Then I got a tech job and realized that, no, most people in tech are still just making ends meet due to the insane cost of living that descends like a dark cloud anywhere a thriving tech scene springs up.
Where I'm sitting, in SF, I see an industry of upper middle class people who are more "wealthy" than "not wealthy." Now, there are plenty of people with paper-money options and below market salaries (which are still above $100k unless you're a masochist), but mid+ level engineers who are willing to work in a company with liquid or semi-liquid equity and that is doing alright for itself are having no trouble, even in todays insane real estate market.
I think the spirit of this is misguided and goes against the spirit of the compensation. The stock based compensation is designed to align everyone's incentives as well as filter for individuals who believe in the prospects of the company.
Hedging out your stock based compensation goes directly against this, and misaligns you with the rest of your company. I think if you don't believe in the companies prospects it is best to take another job or ask for more cash and less equity.
No not really. Being an employee itself is a 'hedge against risk'. As an employee with this kind of 'insurance' you still want the company to do well and have the stock go up in value because it personally benefits you.
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[ 4.4 ms ] story [ 108 ms ] threadIt doesn't work for non-listed startups. Lots of idiosyncratic risk, and no liquid market in the shares.
I could retort with an equally glib "why don't employers just pay their employees in cash?"
Cash for startups with strongly and increasingly negative cashflow is NOT cheap.
You are right that you get leverage with options, but there is no free lunch.
If by "this will work" you mean you will likely have the SEC, IRS, the company's own litigation department, and perhaps the FBI filing various civl and criminal charges against you, then yes it will work.
As "prostoalex" stated earlier, this is insider trading. Even if the person doing it thinks it isn't, it will be up to them and their lawyer to prove otherwise (a.k.a. "the defendant"). And that kind of proof don't come cheap (think $200,000+ USD depending on how pissed off the employer is).
What, did you think you were the first to think of this?
The best advice is simply to sell as early as possible (note, this is not financial advice).
But the important thing is that during salary negotiation, asking for everything in cash is not an option. So actually turning down equity based compensation (at least in this case, I'm not commenting on pre-IPO situations) is extremely bad advice. Equity should be discounted because of the risk, but RSUs are worth real money and should be treated as such.
[0] https://www.linkedin.com/pulse/20140918211244-22433455-your-...
It is not sufficient to discount them for business risk or interest rate risk or any of the other common risks; they must also be discounted for concentration. Unless you were born into a large trust fund or have already accumulated vast wealth (and expect to work for only a short time more), the discounted present value of your expected future salary is going to be your largest asset. That asset is substantially dependent on the business and market fortunes of your employer; therefore, any further exposure to those fortunes represents additional excess concentration. Even if your downside exposure is limited, as it is with RSUs and options, that exposure must be devalued if it represents excess concentration. For most people, the proper devaluation is going to be 100%. You already have too much exposure to your employer. You want to lay off that exposure any way you can (as the author understands), not add more by accepting equity in lieu of cash.
It's simply not correct that demanding cash is not an option. It's a business negotiation; anything is an option. You may not get all, or even any, of what you want, but categorically refusing to ask for it is seldom a winning strategy.
>For most people, the proper devaluation is going to be 100%.
The author argues, correctly, that exchanging stock for its current market value is a good deal. I agree (and I also agree with you that there is extra risk from having your own company's stock). But from none of this does it follow that we should discount stock units by 100%. That is like saying that an offer of $100 with 50/50 odds, would be worth 0, or would be worth zero if the coin toss was correlated with some life event.
I think the problem with your reasoning is that you are treating risk as a concept of independent importance, while it is really a derived concept, with the fundamental concept being the utility from a probabilistic cash flow.
>It's simply not correct that demanding cash is not an option. It's a business negotiation; anything is an option. You may not get all, or even any, of what you want, but categorically refusing to ask for it is seldom a winning strategy.
Having been involved in these negotiations and seen people's salaries and stock grants (through legitimate means), I can say that trying to get more base salary is really hard, and not worth the time. Even if you got more salary, it would come at the cost of so much less stock that it wouldn't be worth it.
Also, how would you ever get caught if you just ignored what it said in the handbook?
At this point, I assume that everything you do is known to everyone. It's unfortunate, but it's also the sensible assumption. Even if the law would seem to prevent them from discovering your actions, there's no reason to believe that law will actually protect you. At the very least, they can almost always fire you without any reason at all, so even the slightest suspicion is sufficient. They don't need to prove it in criminal court.
(I expect transaction costs would nuke this idea, but I'm somewhat curious how sophisticated big company employee agreements are.)
Short the index and long everything but your SECTOR is probably OK. That's just a bet against your sector. Short the index and long everything except your specific COMPANY is not going to be defensible. (In my policies, it's more straightforward to just short the sector directly, if such an instrument exists.)
I've worked in finance and for several publicly traded companies and have never been barred from trading stock in our competitors (other than if they were a takeover target or potential acquirer in active talks with us and that I knew about that, which is vanishingly rare).
You're allowed to own stocks in this example, but you generally wouldn't be allowed to trade on them.
It's not the outcome, it's access to material information. Anyone who has access to sales or revenue information can come to reasonable conclusions in regards to underperforming/overperforming come earnings time, and trade on that information.
> ... the prosecution will assume you had some insider info to trade on. The onus is on you to prove that you didn't.
If you want to tango with people that salivate at prosecuting people which profited from hedging while employed at the company which they hedged, I can only recommend against that course.
It will end badly.
Hedging out your stock based compensation goes directly against this, and misaligns you with the rest of your company. I think if you don't believe in the companies prospects it is best to take another job or ask for more cash and less equity.