I hope executives like you understand your stock options and equity awards so you can make smart decisions and live your ideal lifestyle. There are five elements of understanding what a stock option is: understanding the vesting schedule, knowing that the value of your options, both the intrinsic value and the time value, and understanding the type of option, the non-qualified versus the incentive stock options, as well as the tax consequences associated with each, and last but certainly not least when to exercise your options. The number one question I'm asked is: when should I exercise my options? In this video, I will talk specifically about when to exercise the options. Wouldn’t it be great if you could have the basic template to assist you with the decision-making process? Well, now you can. So let's go ahead and get started. I think it would be helpful to spend a minute discussing the time value versus the intrinsic value. In the previous video, I explained that the intrinsic value is the difference between the exercise price and the current price of a stock. For example, if the options were granted at 20 and the stock option is currently trading at 30, the intrinsic value would be $10 per share. The other component that makes up the value of the option is the time value. This is the theoretical upside potential of the option. The keyword there is potential. In essence, the time value of an option is like an interest-free loan exercise price plus the potential increase in the value of the option. The challenge that the executive faces is what we call the option holder's dilemma, meaning the only way to protect the option's value is to destroy the value. In other words, by exercising the option, you're destroying the value and protecting the upside, but you're also protecting the value by exercising the option and capturing the gain. So, what makes up this time value? First, time to expiration. The longer the maturity the greater the time value is. Second, interest rates, as I mentioned earlier a stock option is like an interest free loan therefore interest rates are higher than the option values are higher and third the volatility. Normally investors prefer less volatility in their investments, however when it comes to options the greater the volatility the more that an option is worth. Fourth, dividends. The greater the companies dividend, the lower the value of the options is. As the option owner, you're not entitled to receive any dividends, making the option less valuable. I have seen several different strategies, or should I say methods, that executives have used in exercising stock options, and I will touch on each of them and then show you a simple method you can use that I feel is the most effective without the use of sophisticated software. One method is called the first opportunity, or as soon as possible, as the name implies; this is when the executive exercises the option at the first opportunity. The advantage of this method is that it protects the profit of the option by exercising as soon as possible, but obviously, exercising the first opportunity will leave any time value gone once exercised. This method would be the least risky.  Another method is called the last opportunity or as late as possible. While this gives the executive the greatest profit potential, it has the greatest risk by waiting to exercise the options shortly before they expire. Another method I have seen used is called the specific time period, which is a combination of the first two. It is when the executive exercises the option based on a specific time period that has passed the expiration date. That could be four, five, or six years, assuming that the option is in the money. This method is more favorable than the other methods as it balances the risk-return. However, the flaw of this method is that it assumes that the amount of time remaining before expiration determines the best time to exercise the options. The method I have used as an initial starting point with executives is called the profit percentage. The profit percentage is the dollar amount of profit by exercising the option divided by the current stock price. For example, if the current stock price is at $40 per share and the exercise price is at 30, we have a $10 profit divided by the current price of 40, which gives us a profit percentage of 25 percent. If the stock goes up to $65 a share, we still have the same $30 exercise price, but our profit is now 35 divided by the current price of 65, which gives us a profit percentage of around 55 percent. Obviously, the greater the profit percentage, the more it makes sense to exercise the options. Determining what the profit percentage should be before you exercise your options really varies dramatically for each executive. There are several factors that I would look at in determining what the profit percentage should be and determining what options to exercise. These would include the concentration of your company stock, in other words, what percentage of your net worth is in your company stock, including the stock options. Also, the time frame until the funds are needed. If you're an executive in your mid-40s versus an executive looking to retire in the next few years, obviously, the profit percentage would be different. Also, your risk tolerance and your attitude towards risk, as well as job security, are important. How secure do you feel in your present job? In general, I wouldn't suggest exercising your options with less than a 20% profit percentage unless the option is getting close to expiration. Also, once the profit percentage gets above 60 percent, the majority of the time value has been recognized, and holding the option longer may not give a lot of extra return versus the risk of holding on to the option. Generally, the majority of the errors that the executives make in determining when to exercise their option isn’t when the profit percentage is in the mid-range of 30 to 60%, but when the profit percentage is extremely high, like 80 to 90 percent and the options aren’t exercised. The stock drops substantially due to the overall markets or something going on at the company. In summary, the profit percentage is a great starting point in determining when to exercise your options. As you may have gathered, the biggest downfall to the profit percentage is that it doesn't take into consideration the time value. In my next video, I will introduce the use of technology and valuing stock options that use the black Scholes model and key statistics to help determine precisely what options to exercise and when to exercise them.