Writing Covered Calls against Employer Stock Plan Shares (ESPP, Restricted Stock, and Stock Options) – A Primer

Employee stock plans are typically administered through national brokerages such as Fidelity and Etrade. These brokerages generally arrange a stand-alone account per employee to hold stock allocations. Such accounts differ from the ones employees open on their own for the following factors:

• Tax is withdrawn and reported through W-2 automatically for certain types of stock plan transactions. For example, when restricted stock is allocated, there is an automatic sale and withdrawal of a portion of the allocation.
• Transfer and trading restrictions on the account.
• Additional restrictions can be placed at the employer’s request any time.

As mentioned previously, opportunities exist to realize long-term capital gains tax rates on the sale of Employee stock. Most employers set restrictions on the employer sponsored account to disallow options trading thereby reducing the employee’s options in disposing shares from ESPP using covered calls based strategy. Writing short-term near-the-money covered calls is a good strategy compared to selling shares immediately because of the following:

• Majority of the employees participating in ESPP tend to recycle the shares as soon as they are available in their accounts. This creates temporary selling pressure and can keep the shares artificially down. Writing near-the-money, near-term covered calls instead allows for a little more flexibility.
• Writing covered calls following a spike in the shares can be beneficial than selling the shares in instances where holding on for a short while longer could deem those shares a qualifying disposition. There is a subtle difference in the tax treatment of qualifying vs disqualifying dispositions even in situations where ownership has been for more than a year to qualify for long-term capital gains – this can be significant in cases where the share price has gone down since the purchase:

• For a disqualifying disposition, the “bargain element” (the market price at the exercise date minus the actual price you paid for the stock) is ordinary income.
• For a qualifying disposition, ordinary income is the lesser of the “bargain element” and “sale price MINUS purchase price”.

One way to circumvent options restrictions on ESPP shares is to transfer the shares from the Employer Sponsored Account to the brokerage side of the account. Normally this entails having to wait for the shares to become eligible as a qualified disposition. When the shares become eligible for transfer, a transfer request is all that is needed and on completion of the transfer (1-5 business days depending on broker), the shares are exempt from Employer trading restrictions and thus eligible for use in writing covered calls.

Related Posts:

1. Flexible Spending Accounts (FSA) – Great Benefit with a few caveats!.
2. Writing Covered Calls against Employer Stock Plan Shares (ESPP, Restricted Stock, and Stock Options) – A Primer.
3. Employee Stock Purchase Plan (ESPP) and 401K Retirement Plan Annual Enrollment and Contribution Review.
4. Employee Stock Purchase Plan (ESPP) - Immediate Selling Strategy.
5. Realizing Long-Term Capital Gains With Stock Based Compensation.
6. Stock Based Compensation Tax Optimization Strategies.

 Last Updated: 01/2015.