Ask the Fool: What's a stock option strike price?

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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.

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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.

Fool’s school

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.

My smartest investment

Big and still growing: My smartest investment has been buying shares of Starbucks. It wasn’t my favorite coffeehouse, but if you can’t beat ’em, join ’em! Now, as they open more and more stores, I’ll benefit. — R.E., online

The Fool responds: That’s a great way to look at it. It can be satisfying to invest in solid and successful companies that you don’t love, especially increasingly dominant ones, because the profits you’ll make as they grow can outweigh your annoyance. Owning shares means you’re an actual owner of part of the company – albeit a very small part – and that can make you root for the company to succeed.

Like most businesses, Starbucks got whacked by the pandemic, but its recent earnings report revealed sales returning to positive territory in China, while declines were cut in half in the core U.S. segment. (Sales in China grew 5% year over year, compared to a 3% drop in the prior quarter, and the U.S. segment’s drop shrank to 5% from 9%.)

With more people getting vaccinated around the world, the global end of social distancing may come soon after the coffee giant celebrates its 50th year as a company that prides itself on being a gathering place.

“We are here for that great human reconnection,” CEO Kevin Johnson has said. “Starbucks was built for this moment.”

It has more room for growth, too. With nearly 33,000 locations today, it’s aiming for 55,000 by 2030.

Foolish trivia

Name that company: I trace my roots back to 1903, when my namesake bought a struggling curtain rod company in Ogdensburg, N.Y. I grew over time, in part via dozens of acquisitions. Today, I’m based in Atlanta. With a market value recently topping $11.5 billion, I’m a global consumer brand powerhouse, with some names you might know: Rubbermaid, Paper Mate, Sharpie, Dymo, EXPO, Parker, Elmer’s, Coleman, Marmot, Oster, Sunbeam, FoodSaver, Mr. Coffee, Rubbermaid Commercial Products, Graco, Baby Jogger, NUK, Calphalon, Contigo, First Alert, Mapa, Spontex and Yankee Candle. I also used to own Jostens, the class-ring company. Who am I?

Last week’s trivia answer: I trace my roots back to 1993, when I was founded in St. Louis. I went on to acquire cable systems across the nation, but was deep in debt – and trouble – by 2009. I spent much of that year in Chapter 11 bankruptcy protection but emerged stronger. Microsoft co-founder Paul Allen held a controlling stake in me for about a decade. Today, with a market value recently near $136 billion, I’m a major telecom enterprise. I have the Spectrum brand, a network of more than 750,000 miles and more than 31 million customers in 41 states. Who am I? (Answer: Charter Communications)

The Motley Fool take

Profits brewing? Anheuser-Busch InBev (NYSE: BUD) has had a challenging year, as the global pandemic closed bars and restaurants, exacerbating the change in consumer preferences for alcoholic beverages toward hard seltzers. Yet it would be foolish for investors to write off the world’s largest brewer with hundreds of brands to its name.

The company had been working on reducing its massive debt load (largely from its 2016 acquisition of SABMiller) before the pandemic struck, but the COVID-19 outbreak forced it to add more debt and suspend its dividend to preserve cash. It has been diligently paying down its debt, though. And it’s pursuing the hard seltzer trend with various brands in its portfolio, such as Bon & Viv.

AB InBev’s beer business has struggled, but it has followed the premiumization trend in alcoholic beverages. As one example, its Michelob Ultra accelerated its gains and remains the second-highest selling beer (in dollars) in the U.S. after Bud Light. CEO Carlos Brito believes this year’s beer sales will “improve meaningfully” compared to last year’s figures; ditto for earnings.

The big brewer may be down at the moment, but it has a huge international presence and cost advantages from its great scale. The global economy is likely to pick up in the coming year or two as parts of the world put the pandemic behind them, and AB InBev’s future looks promising. (The Motley Fool has recommended Anheuser-Busch InBev NV.)

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