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Lesson 2. Why Options Are Important > Options and Your Portfolio - Pg. 9

Why Options Are Important 9 If you are granted nonqualified options (NSOs), you are not liable for any taxes until you exercise the option and buy the stock. At that point you pay ordinary income tax on the difference between the strike price and the price of the stock on the day you exercise your options. More about taxes in Lesson 9. You may not want to exercise the option for a variety of reasons, including avoiding the tax liability. For example, suppose you were just a few years away from retirement and making a significant salary. If you bought the stock and sold it you might face a tax bite of 35 percent or more out of the proceeds. This could eat up most or all of your profit. If you wait until you are retired, your income tax rate could drop to 10 percent or 15 percent, making the transaction more profitable. Check to see what your plan's provisions are for people who retire. Companies often let retirees exercise their options for some time after retirement, but there is no hard-and-fast rule. Plain English Capital gains tax is a special tax rate that applies to profits from investments. If you own an investment for more than one year you qualify for the lower rate. You may also not have the ready cash to buy the stock if your goal is to own the stock. If your options have a 10-year life span, there may be a time in the future when you will have the cash to buy and hold the stock. A note of caution: Stock prices can fall during this waiting period, making your options worthless. If you are in this situation, you need to have a thorough understanding of your financial situation and a backup plan to react to falling stock prices. Alternative Number Three