Question 1

What does "out of the money" mean for startup employees?

Accepted Answer

Out-of-the-money (OTM) means your stock option strike price is higher than the company's current fair market value (FMV). If you exercised today, you'd pay more per share than the shares are worth — a guaranteed loss. Example: your strike price is $2.50 but the company's current 409A valuation puts FMV at $1.80. Every option is underwater by $0.70. Your options only become valuable again if the company's FMV rises above $2.50.

Question 2

What's the difference between "out of the money" and "underwater" options?

Accepted Answer

There's no difference — they describe the exact same situation. "Out of the money" is the technical financial term used in options pricing theory. "Underwater" is the colloquial startup industry term. Both mean the strike price exceeds the current fair market value. You'll hear investors and finance professionals say "out of the money" while founders and employees tend to say "underwater." Understanding that they're synonymous helps you follow conversations about your equity without confusion.

Question 3

Should I exercise my out-of-the-money stock options?

Accepted Answer

Generally no — exercising OTM options means paying more than the shares are worth, which is an immediate loss. However, there are edge cases where it makes sense: (1) Early exercise at a very low strike price before a valuation correction means you may have already paid minimal cash and can start the capital gains clock. (2) If you believe strongly in recovery and your options are near expiration, early exercise locks in your position. (3) Tax strategy in specific situations may favor it. For most employees, the right move is to wait and see whether the company's valuation recovers above your strike price before making any exercise decision.

Question 4

What can a startup do when employee options go out of the money?

Accepted Answer

Startups have four main options: (1) Repricing — lower the strike price to match current FMV, giving employees back their incentive. Must comply with Section 409A and ASC 718 accounting rules. (2) Option exchange programs — employees voluntarily trade underwater options for new at-the-money options, RSUs, or cash, typically on a value-for-value basis. (3) Alternative compensation — shift to RSUs or cash bonuses that don't depend on strike price. (4) Wait for recovery — if the valuation correction is temporary, sometimes the best response is patience. Most startups doing repricing after a down round choose option 1 or 2, since they preserve employee ownership without new share issuance.

Question 5

What's the difference between in-the-money and out-of-the-money options?

Accepted Answer

The difference is whether your strike price is below or above current fair market value: In-the-money (ITM): strike price < current FMV. Your options have real intrinsic value — you could exercise and immediately profit. At-the-money (ATM): strike price ≈ current FMV. No intrinsic value, but the option still has time value if the company grows. Out-of-the-money (OTM): strike price > current FMV. No intrinsic value, and you'd lose money if you exercised today. Most startup employees are granted at-the-money options (strike set at current FMV via 409A), which become in-the-money if the company grows and out-of-the-money after a down round.

Question 6

How does the 409A valuation determine whether my options are out of the money?

Accepted Answer

Your strike price is set at the 409A FMV on your grant date and never changes. The company's 409A valuation is updated periodically (at least annually, or after major funding events). If the new 409A FMV drops below your original strike price, your options are now out-of-the-money. Example: You received options at a $3.00 strike (the 409A value when you were hired). A down round triggers a new 409A putting FMV at $1.75. Your options are now underwater by $1.25/share. You can check your current option status by comparing your grant strike price (in your equity agreement) against the company's current 409A valuation (ask HR or your equity platform like Carta).

Question 7

Will my out-of-the-money options ever recover their value?

Accepted Answer

Yes, if the company's valuation grows back above your strike price. Options recover value the same way they lost it — through changes in the 409A FMV. If the company raises a new round at a higher valuation or hits a liquidity event above your strike price, your options become in-the-money again. Recovery is never guaranteed, but many employees who held underwater options through downturns ended up with valuable equity at exit. The key factors to consider: How far underwater are you (10% vs 5x)? What's the company's trajectory? How long until your options expire (usually 10 years from grant)? If you leave, you typically have 90 days to exercise or forfeit — even OTM options.

Question 8

What mistakes do employees make when their options go out of the money?

Accepted Answer

The most costly mistakes: (1) Exercising OTM options — paying cash for shares worth less is throwing money away unless you have a specific tax or timing reason. (2) Forfeiting too quickly — employees who quit without exploring recovery timelines leave potential upside on the table. Remember you typically have 90 days post-termination to exercise vested options, even OTM ones worth holding for the company's future. (3) Ignoring repricing opportunities — if your company offers a repricing or exchange program, evaluate it seriously rather than dismissing it. (4) Assuming the options will never recover — many founders confuse a valuation correction with company failure.

Question 9

Are there tax implications for holding out-of-the-money options?

Accepted Answer

Holding OTM options has minimal immediate tax impact since you haven't exercised (no purchase event). However, a few nuances matter: For ISOs: No tax event occurs just from holding, even if underwater. The AMT exposure you feared on exercise disappears when options are OTM. For NSOs: Same — no tax event while unexercised. For repricing: If your company reprices your options, the new options may be treated as newly granted, restarting your ISO/NSO tax treatment and holding periods. For exchange programs: Exchanging underwater options for new grants is typically treated as a new grant for tax purposes, potentially affecting ISO status. Always consult a tax advisor before making decisions about OTM options, especially around expiration, termination, or repricing events.

Question 10

Why did so many startup options go underwater in 2022-2023?

Accepted Answer

The 2021 startup funding boom drove valuations to historic highs, and many employees received options priced at those peak valuations. When interest rates rose sharply in 2022, investor risk appetite fell, funding dried up, and valuations corrected 40-80% from their peaks across the tech sector. Companies that had raised at high 2021 valuations were forced into down rounds — raising capital at lower valuations — which triggered new 409A appraisals at reduced FMVs. Employees who joined in 2020-2021 found their strike prices suddenly above the new FMV. This was widespread: Carta data showed a significant increase in option repricing programs in 2022-2023 as companies tried to retain talent whose equity had gone underwater.

Out of the Money

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