Strike that

Q: What’s a stock option’s “strike price”? — T.F., Richmond, Virginia

A:

The strike price is the price at which the option can be exercised.

Let’s say you work for Dodgeball Supply Co. (ticker: WHAPP) and receive 100 stock options with a strike price of $20 each. Later (and before the options expire), if Dodgeball Supply’s stock is trading at $45 per share, you may decide to “exercise” your options.

Since your options carry a strike price of $20, you’re can buy up to 100 shares at $20 each — not their going price of $45. To exercise them all, you’ll hand over $2,000 for 100 shares worth $4,500. You can hang on to them as long as you like, or quickly cash out for a $2,500 profit.

Of course, it’s a little more complicated than that. There are tax issues to consider, for one thing, and company stock options do expire. Read your stock option plan’s rules carefully, and consider seeking professional financial advice. Kaye A. Thomas’ book “Consider Your Options: Get the Most From Your Equity Compensation” (Fairmark Press, $24) may also be helpful.

Q: How can a stock start trading in the morning at a higher price per share than the price at the close of trading the day before? — M.G., Chicago

A: The price may have risen during after-hours trading, or demand for the shares may have built up overnight — perhaps due to good news released, such as a very strong quarterly earnings report.

If buyers are willing to pay more for the shares, sellers will sell them for more. A stock’s price reflects the last price at which someone was willing to buy it and someone else was willing to sell it.

Volatility is normal

If you want to invest in the stock market, you’ll need to expect volatility and to be able to deal with it appropriately.

In 40 of the past 50 years, the stock market, as measured by the S&P 500 index, gained in value. In 18 of those years, it gained 20% or more — between 10% and 20% in 13 years, and between 0% and

10% in nine years. The other 10 years featured losses; in three of those years, the market lost more than 20%. Clearly, stock investors need to expect many ups and downs — with more ups than downs.

Here’s what that all amounts to over those 50 years: an average annual gain of 10.9%. That’s terrific, but it’s even more useful (and realistic) to adjust that for the effects of inflation, which brings it down to an annual average inflation-adjusted gain of 6.8%. If you’re investing in stocks and expecting to enjoy returns of 25% or more every year, you’re not likely to meet those expectations. But over long periods, if you invest meaningful sums regularly, you can amass a hefty nest egg. Your portfolio won’t necessarily average 10.9% growth — it might grow by more or less — perhaps, say, 7% to 12%.

Note that the market’s volatility is often expressed in points, not percentages. You’ll see, for example, a headline shrieking, “The Dow crashed 500 points today,” which can sound alarming. But since the Dow Jones Industrial Average was recently above 33,000, a 500-point drop would be just a 1.5% decline. Percentages give you a clearer picture. (Back when the Dow was at 2,500, a 500-point drop would have represented a much sharper fall of 20%.)

Most market corrections tend to last just a few months, and relatively few last more than a year. So expect drops in the market, and don’t panic. Instead, try to grab some shares of great companies when they’re on sale. And keep any short-term savings — money you may need in the next five or so years — out of stocks.