An underwater stock option is one where the exercise price is higher than the current market price of the underlying stock. If the stock is trading at $40 per share and the option’s strike price is $60 per share, exercising the option would mean paying more than the shares are worth. The option has no intrinsic value at that moment.
For Houston executives going through a divorce, underwater options present a unique set of challenges. On one hand, they are technically worthless today. On the other hand, they may become valuable in the future, and ignoring them entirely in the divorce settlement creates the risk of one spouse receiving a windfall years later.
Are Underwater Options Community Property?
The mere fact that an option is underwater at the time of the divorce does not change its characterization as community or separate property under Texas law. Texas Family Code section 3.007 applies regardless of current value. If the option was granted during the marriage and has not yet vested, or vested during the marriage, the formula still applies to determine the community fraction.
What changes is the valuation and the strategy for division. An option with no intrinsic value still has time value if it has not expired, because the stock price might rise above the strike price before the option expires. Financial models such as Black-Scholes can assign a positive value to underwater options based on their remaining time to expiration and the volatility of the underlying stock. That value may be modest, but it is not zero.
Division Strategies
For truly deeply underwater options where even the time value is minimal, the most practical approach is often to acknowledge the options in the decree and establish a mechanism for sharing proceeds if they ever come into the money. The employee retains the options and agrees to pay the former spouse their community share of net after-tax proceeds if the options are ever exercised at a profit.
For options that are only modestly underwater and have significant time value, a more active valuation and potential offset may make sense. If the stock is volatile and the expiration date is several years away, the option may have real economic value that the non-executive spouse should receive credit for.
One important practical consideration is the option expiration after employment termination. Most plans give employees only 90 days to exercise vested options after separation from employment. If an executive is terminated during the divorce process, any vested options that are not exercised within that window will expire worthless. The decree needs to be aware of these deadlines and ensure that both spouses understand the risk. An option that was valuable community property can vanish if the employee fails to exercise it in time.
Support Implications
Underwater options may still be relevant to spousal support calculations. Texas Family Code section 154.062 defines net resources for child support to include all wage and salary income and other compensation. When underwater options are exercised after the stock recovers, the spread is compensation income that factors into support calculations. Settlement agreements sometimes include provisions for supplemental support payments tied to future option exercises that exceed a threshold value.
For more on dividing stock options generally, see our article on dividing unvested stock options in high-net-worth divorce.
The Tactical Use of Underwater Options in Settlement
Some executive spouses intentionally minimize the value attributed to underwater options in negotiations, hoping the other spouse will agree to ignore them entirely. The non-executive spouse should resist this. Even a deeply underwater option may become valuable within its remaining exercise window if the company’s stock recovers. An option with five years remaining and a strike price only modestly above market may have significant time value according to a Black-Scholes analysis.
A balanced approach is to include underwater options in the decree with a simple “if and when” provision that costs nothing to implement now but protects the non-executive spouse if the options come back into the money. Neither spouse is harmed by acknowledging the options, and the non-executive spouse avoids the risk of watching the executive exercise a windfall later that was completely invisible in the settlement.
For Houston-area executives at oil and gas companies, technology firms, and healthcare corporations, stock prices can be highly volatile, and options that are underwater during an industry downturn may become very valuable during a recovery. Working with a Houston divorce attorney who understands both the legal framework and the business context gives both spouses the best chance of a settlement that accounts for the full range of possibilities.