The question: Stocks or options?
One of the most common questions that investors have is whether to buy stocks or options. Stocks are a long-term investment which will not do well when the market is volatile. Options are best for people who want to trade and make some money in short period of time or need to control risk by hedging.
So how do options versus stocks compare? When you buy an option, you take on all the risk associated with that option but if your prediction is correct then you can make a significant profit in a short period of time. However, when you buy stocks, your risk is spread out over several years and if things don’t go your way then it may take much longer for things to recover.
If you are new to investing, the easiest way to start off is by purchasing a stock or some other security. As you become more experienced there may come a time when it makes sense to move on from stocks and add a new tool to your investment toolbox: options. If you have a basic understanding of trading then this may be an excellent choice for you.
Based on your investing style, you can decide whether stocks or options are better for you. Beginners will generally stick to stocks for their simplicity. Those who like to watch the market and prefer an active investment approach may find options appealing.
If you don’t know a new vocabulary of terms like puts, calls and strike prices, you may think options are riskier than stock options. That’s not correct because investors can let an option expire without any further financial obligation.
Investors are often interested in minimizing risk whenever possible, and when they hear the word “options”, they automatically believe that whatever they are considering will be more risky, but this is a misconception. Investors can avoid or mitigate risk by opening an option using a Call option because if the market price of an asset rises even further, then the investor will lose only what they spend on that option.
Another thing you need to know about long term investors is they often use options as a form of insurance to protect their investments against market fluctuations. When investors use options in order to secure their portfolio against market fluctuations, it’s called “hedging.” Instead of selling stocks when a tough period lies ahead, they simply purchase put options.
What are the differences between stocks and options?
Both options and stocks provide unique advantages and disadvantages. So, there’s no reason why you shouldn’t use both methods simultaneously.
While stocks give you a small piece of ownership in a company , options are just contracts that give you the right to buy or sell stocks at a specific price by a specific date.
Stocks may be the most popular choice for long-term investing or if you are a beginner, but options can also be a smart alternative or addition for your portfolio. No matter if you’re deciding between options and stocks or want to combine the two, you need to study several factors, including your goals, timeline and risk tolerance.
Both options and stocks require careful analysis of their respective merits. Before deciding which path to follow, ask yourself some questions. What’s my goal? Do I plan to hold onto an investment for years or months? Which method provides me with greater liquidity ? Does either strategy help me achieve my overall objectives?
It is becoming clear that there are two different skill sets required for trading stocks and options. Let’s compare stocks and options in detail.
Stocks Trading or Options Trading? Pros & Cons of Each Investment Style
Pros of stocks
a) You own part of the business. With stocks you have instant equity. When buying options you have to wait for the option to expire before you can find out if you made a profit or a loss. As a stocks shareholder, you get dividends and voting rights . Dividends come out quarterly, usually around April 15th. Voting rights give shareholders power to elect board members, change corporate policies, and approve new projects. Shareholders typically vote every year whether to increase or decrease the number of shares outstanding. Shares trade on major stock exchanges throughout the world.
b.) Stocks don’t expire. You own them for the lifetime of the business as long as it exists. Not for nothing, many market participants prefer long-term investment strategies . This investment comes with many benefits and is good for making a long-term passive income. If you are a serious investor who has been looking for a way to generate income through investments for a long time, then you must try out investment technique of long-term investment.
d.) You invest in the company behind . One way to invest in stocks is to simply buy them directly from a company’s stock market listing. This is called “purchasing shares”. When you purchase shares of a company, you are actually investing in the company itself and you become a shareholder. As a general rule, the more shares you buy, the more “
d.) Lower risk and leverage 1. An investment in the stock market is never risk-free but it is considerably less risky than most other investment vehicles.
Cons of stocks
a.) There is an inherent volatility in the market. There will be times where the price goes up and times where it goes down. This means that you could make money one day and then lose money another day.
b.) Buying stocks requires more time and resources. It takes longer to research companies and understand how they operate. The process involves reading articles about the industry, researching the fundamentals of each company, analyzing earnings reports, watching news stories and talking with other people involved in the business.
c.) You can’t profit from falling prices. When the value of a share falls below its purchase price, you have no way to turn this into profits. Your investment returns depend on the performance of the overall economy. While some industries do well during recessions, others struggle. For example, technology has been doing very poorly since the recession began in 2008.
d.) All of your assets can become worthless. Creditors might liquidate it. Investors would receive a small fraction or nothing in bankruptcies , if there’s not enough cash available to pay back creditors, investors, and customers.
e.) Managing stock portfolios is hard work. Some investors have a handful of stocks. Others have hundreds of stocks. If you’re like most investors, you fall somewhere in the middle. You probably don’t have time to research each of the stocks in your portfolio and need help with managing the portfolio.
f.) You are invested all the time. Stock prices change everyday because of what’s happening in the economy, what new products are coming out, who’s buying or selling stock, etc. Therefore, it is important to analyze how the economy, certain companies, and even certain stocks are performing on a daily basis. Are you willing to check your stocks every single day, over years?
g.) Sudden market fluctuations. These events don’t happen often. But when they do, you may have to move quickly. If you’re a business owner, selling stock to raise cash can be a lifesaver. Contrary, with options you try to use implied volatility to leverage your potential profit while capping your maximum loss. Smart, isn’t it?
Pros of options
a.) Option contracts give you much higher leverage and bind a lower amount of capital. The use of margin allows investors to control a larger asset base. The high degree of leverage associated with options can significantly increase the capital gain on an investment as compared to buying a company’s shares outright. This is particularly of interest for day trading.
b.) You know your potential loss before. Contrary to stocks trading or speculation on futures contracts, your risk is limited to the price of the option, the option premium . If an option buyer makes a wrong bet and if the price at expiration is below the strike price, he loses the price of the option. However, if your prediction is correct, then you can make a lot of money.
c.) You make a future bet on the price. You buy a call option when you think the underlying stock will go up in price. If you think the underlying stock price will drop in the future, then you buy a put option. This is basically just a bet on the future price of the stock.
d.) You can use options as insurance. Similarly, they can help increase your portfolio’s diversity.
e.) Wish to trade actively. If you want to trade actively, then options could serve you very well because they let you profit from anticipated movements in prices. They are good when you want to trade and make some money in a short period giving the investor much more flexibility and control when it comes to the timing of buying and selling the underlying asset. And they offer greater control and less effort than stocks. You have the possibility to trade based on your own judgment rather than waiting for prices to move up or down.
f.) Ability to generate income from shorting : Options allow investors to profit from both rising and falling prices in the underlying assets.
Cons of options
a.) When you purchase call/put options, you’re actually giving up ownership rights to something – so you could potentially lose everything if the option expires worthless!
b.) The fair market value of options is harder to estimate than for stocks , especially for beginners. Options can be highly risky, and therefore may not be suitable for all investors.
c.) Options have higher fees than stocks. In general, there is a higher spread too.
d.) Options don’t pay dividends.
e.) One major disadvantage of options is that they are not available for all underlying securities , and therefore investors may have fewer opportunities to invest.
f.) Learning Options Trading takes time . It can be a daunting task when you are first starting out because there are so many different aspects to learn about. However, the advantages of trading options outweigh the disadvantages, and a sophisticated options strategy is one of the most powerful ways to invest your money in today’s market.
Can you invest in stocks and options at the same time?
You can be an active investor in stocks and options at the same time. Many individuals do not realize this until they try to invest in both options and stocks. For instance, an individual could hold some stocks directly and also trade options against those positions. Or, he/she could own stocks outright but still hedge their position by trading options.
You can’t keep your options contract forever, unlike stocks. Common options contracts expire after three, six, or twelve months. Buying stocks directly is better for long-term investors while using a stock option is easier for short-term strategies and hedging risk. When it comes to choosing which strategy works best for you, consider what kind of investor you are. If you enjoy watching the markets closely, then options might work well for you. However, if you’d rather focus more on making money from investments, buying shares in companies may suit you better than being an option holder.
The bottom line is that both types of investments offer benefits. It all depends upon how much control over your finances you desire.
Key Takeaways – Comparing Stocks and Options
1. You have two main ways to invest in securities: through direct ownership or via derivatives.
2. There are pros and cons to each approach when we compare stocks vs options. In general, option traders tend to be less concerned about nervous markets than stock traders.
3. An option contract allows you to buy something at a certain price within a specified period of time. You decide whether to take advantage of the opportunity the option seller guarantees you. Contrary, stocks give you partial ownership of a company.
4. Options are for active traders and allow you to make profits with predefined risk in both directions of the market. Stocks are for long-term investors who believe in rising markets.
5. Options can be used for shorting markets and therefore for hedging risk. In this case, stocks and options are often used at the same time.