When a stock trades below an option’s exercise price, the option is “underwater.” Exercising it today would mean paying more for the shares than they are worth. In energy and other cyclical industries common in Houston, options can sit underwater for years and then recover quickly. Treating them as worthless in a divorce can hand one spouse a windfall later.

This guide explains how underwater options are characterized, valued and divided in a Texas divorce, and what executives and spouses in Houston, Humble, Pearland and the surrounding area should write into the decree.

Underwater does not mean worthless

An option has two components of value:

• Intrinsic value: the stock price minus the exercise price. For an underwater option, this is zero.
• Time value: the chance the stock rises above the exercise price before the option expires. Option pricing models such as Black-Scholes assign a positive value to that chance, which grows with the time left and the stock’s volatility.

An option with years until expiration and an exercise price only modestly above market can carry meaningful time value. A deeply underwater option close to expiration may carry very little.

Characterization does not depend on price

Whether an option is community or separate property does not depend on whether it is in the money. Options granted during the marriage are presumed community property. For options that require employment after the divorce, or that were granted before the marriage, Texas Family Code section 3.007(d) sets the separate and community fractions. See The Time Rule.

Ways to divide underwater options

1. Deferred “if, as and when” sharing. The employee keeps the options and pays the former spouse the agreed share of net proceeds if they are ever exercised at a profit. This costs nothing today and protects against a later recovery. It is often the most practical choice for deeply underwater options.
2. Valuation and offset. For options with significant time value, an expert can value them, and the non-employee spouse can receive other assets in exchange. This gives a clean break.
3. Transfer. If the plan allows, vested nonqualified options can be transferred so each spouse decides when to exercise. Incentive stock options lose their ISO status if transferred. See ISO vs. NSO Tax Treatment.

Decree terms worth including

• A schedule of every grant, including underwater ones, with exercise prices and expiration dates
• Who decides when to exercise, and whether the employee must give notice first
• What happens if the company reprices options or offers an exchange for new awards; replacement awards should carry the same sharing terms
• What happens if employment ends; many plans give a limited period, often around 90 days, to exercise vested options after termination, so options can expire if no one acts
• Whether shares are measured before or after tax

Because a final Texas property division generally cannot be changed later (Family Code section 9.007), leaving underwater options out of the decree can forfeit a claim that becomes valuable.

Underwater options and support

If options recover and are exercised after the divorce, the spread is compensation income. Texas child support is calculated from “net resources,” which include wage and salary income and other compensation (Family Code section 154.062). Court ordered spousal maintenance is capped at the lesser of $5,000 per month or 20% of the paying spouse’s average monthly gross income (Family Code section 8.055), so how option income is counted can affect the amount ordered. Spouses can also agree to contractual alimony on different terms. See how stock options factor into support obligations.

Talk with a Houston divorce lawyer who handles executive compensation

Chidi Anunobi is Board Certified by the Texas Board of Legal Specialization and holds an M.B.A. from Carnegie Mellon University. We represent executives and their spouses in high net worth divorces involving every type of equity award.

Our office is at 1415 North Loop West in Houston. We serve Humble, Pearland, Spring, Conroe, Katy, Fulshear, Sugar Land, the Heights, River Oaks and all of Harris, Fort Bend and Montgomery Counties. Call 832-538-0833 or contact us. Our executive compensation guide and Dividing Unvested Stock Options go further.

Frequently asked questions

Are underwater stock options divided in a Texas divorce? Yes, to the extent they are community property. Being underwater affects their value, not their character.

How do you value an option that is underwater? By its time value, using an option pricing model. Many couples skip valuation and share any future profit instead.

What if the company reprices the options after our divorce? The decree should say that replacement or repriced awards carry the same sharing terms.

This article is general information, not legal or tax advice.