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Options vs. Stocks

Options vs Stocks, how to decide which one is for you? In this article, we'll cover options versus stocks, what they are, and the drawbacks of each.

Options are usually the next step after stocks for investors. While stocks and options are very similar, they differ in various ways.

In this article, we'll cover options versus stocks, what they are, and the drawbacks of each.

What are Options?

Options are the tactical approach to investing. Options are contracts for investors to purchase or sell assets at a set price up to the expiration date. Investors can buy or sell shares of a company's stocks rather than owning part of said company.

Investors also have to pay a premium with options. If you're looking to pay as little as possible for a premium, you'll purchase close to the expiration date. The larger the gap between the current and expiration dates, the more the premium costs. Additionally, the value of an option decreases as the expiration date approaches.

Types of Options

Generally, there are two types of options: call options and put options.

Call options give holders the right but not the obligation to buy a particular asset at a predetermined price on or before a set date. The default for most options contracts is 100 shares of stock. The purchase price for an option is usually 100 times the published option price.

Put options give holders the right but not the obligation to sell a particular asset at a predetermined price on or before a set date.

American options also differ from European options. American options can be bought or sold any time on or before the expiration date. On the other hand, European options can only be bought or sold on the expiration date.

Options: Pros and Cons

As with most things, options have their advantages and disadvantages. Options provide flexibility. You can see how a trade plays out and can lock in a price without actually committing. Options let you take advantage of price movements without taking as many risks. Honestly, the most considerable risk is related to the premium you pay.

Are you a long-term investor? Well, options are excellent hedging tools. You can buy a put option to help mitigate potential losses if your assets' values go down.

Simply put, the pros of options are:

  • leverage - you can control more stock for the same price
  • fewer risks
  • options can expand your positions in the stock market

With all the advantages options provide in investments, there are also drawbacks you need to consider. Options require a hands-on approach that you may not be used to. It would be best to watch your stock's price if you decide to exercise the option before the expiration date.

While options trading tends to have fewer risks, some strategies can be risker. It's crucial to understand options trading in advance.

Another drawback of options is the related costs, which are usually higher than stocks. Options traders typically pay a flat fee for each trade. As you continue trading, your costs will increase exponentially. You may even pay fees to sell, as well. Finally, don't forget capital gains taxes. You will pay taxes on any profits, and these taxes are higher for assets you've held for less than a year.

Options contracts are also only valid for a set period. The value decreases as the expiration date approaches.

Additionally, if you are going to be investing in options, you best know what you're doing. Trading with options often require:

  • active portfolio management
  • margin accounts
  • lower liquidation

What are Stocks?

Stocks are a straightforward approach to investing. If you're looking for a long-term goal, like retirement, stocks are a good choice. There's no guarantee that you will make a profit. Stocks are volatile. However, the US stock market has proven to be a substantial, long-term investment.

Versus options, stocks are incredibly simple. You buy a stock with the hope that its price will rise so you can sell it at a higher price. You can either hold a stock for years or try day trading. Day trading is when you buy and sell stocks over days or weeks.

Stocks: Pros and Cons

For beginners, stocks are the main entry point into the stock market. Those with a long-term goal are more likely to use stocks than options. Some pros of stocks include:

  • straightforward
  • simple
  • lower expenses
  • more hands-on approach

You also do not need to check on your stocks every day. Just keep an eye on them until you really need that money. Or you can set an alert through an online broker, which will notify you when the stock's price reaches a profitable level.

As with options, stocks have drawbacks as well. The risks here are straightforward: The price of your assets could plummet, and you'll lose everything. Stock performance is unstable, so it is recommended that you invest money that you won't need for at least five years. Also, don't pile all your money into a single stock.

Performance can be affected by many factors, including:

  • how actively you trade
  • commission costs
  • fees
  • capital gains taxes

Options vs Stocks: Similarities

Options and stocks share various characteristics:

  • Buying and Selling: The orders go through a stockbroker, whether you're investing through options or stocks. The orders are typically filled online.
  • Buying Risk: There will always be a risk when it comes to investing in the stock market. In an options contract, your risk is limited to the total amount you paid. With stocks, your risk is limited to the total amount of stock you bought.
  • Selling Risk: Selling stocks opens the door to infinite risks. With options, you also have unlimited risks, as you are giving the right to buy stock from you to someone else. In both cases, a stock price can go to infinity.

Options vs Stocks: Differences

Options vs Stocks: Differences

The main difference between options and stocks is that options are contracts with other investors, while stocks are ownership shares in individual companies. Stocks also do not have expiration dates like options do. Shares do not just become worthless after a particular date.

Other differences you'll see between stocks and options include:

  • Quantities: You can only purchase options in sets of 100 shares of stocks. With stock, you can purchase as much as someone is willing to sell.
  • Selling Risks: This difference is more slight. Put options limit the total risk to the number of contracts you sell, multiplied by the strike price and multiplied by 100 shares per contract.
  • Time: Options contracts become worthless after the predetermined expiration date. Stocks are good until you decide to sell, as there are no expiration dates.

The following table summarizes the key differences between stocks and options.

Characteristic

Stocks

Options

Potential Wins

High

Very High

Risk

High

Very High

Life span

Infinite

Limited (can be as little as weeks)

Brokerage Commissions

None with major online brokers

The typical rate is 65¢, although some brokers may not charge a commission

When can you trade?

Anytime the market is open

Anytime the market is open

Tax

Depending on the holding period, you can be taxed at short-term or long-term capital gains rates.

Depending on the holding period, you can be taxed at short-term or long-term capital gains rates.

The Safest Option

If you want to be 100% safe, trading isn't for you. No matter whether you're trading options vs stocks, there are always some risks. It's crucial that you understand the risks involved and you assess your risk management before beginning.

A solid trading plan is something every investor should do if they want to reduce their trading risks.

However, plan or no plan, many consider options the riskier choice. Options have an expiration date, so the contract could expire and be worthless if you don't act soon enough. You could lose all of the money you paid for an options contract premium if the strike price is not reached before the expiration.

Stocks always have value so long as the stock price remains above zero. While there are still risks, it is definitely the safest option of the two.

Stocks

Options

Good for…

Beginners and long-term investors

Active Investors who need more flexibility

Potential Disadvantages

Risks, fees, taxes

Effort, additional risks, costs

Type

Equity

Derivative

Is Investing in Options or Stocks the Right Call For You?

Options are riskier than stocks. If you're a beginner investor, you should start with investing in stocks. Once you get comfortable, you can consider buying options.

Buying options is an excellent move for advanced and experienced investors to help mitigate losses and complement their stock investing strategy.

In the end, it comes down to whichever type you prefer.

But don't think that you have to pick one and stick with it for a single asset! You don't have to be an options trader for every investment that you have or will have. Options traders essentially become stock traders when buying call options. At the same time, many stock traders utilize options as a hedging tool.

Deciding which one is better for you is your choice to make. Whatever you do, make sure you know what you're doing first - don't go in blind.

Frequently Asked Questions

Frequently Asked Questions

Are Options Better than Stocks?

Maybe you prefer options vs stocks, and that's totally fine. It's entirely up to you. Your preference depends on your:

  • account size
  • investing knowledge
  • experience
  • risk management
  • trading goals
  • trading plan

There's no perfect strategy in investment. Every trader has their own unique strategy (sorry, you can't just copy someone else's strategy because their situation is different).

Make a plan, research, and good luck!

Are Options Harder than Stocks?

In a way, yes, options can be more complicated than stocks. Investing in options requires a great deal of research and knowledge. Your investment thesis has to be right and in the right time period. Stock that rises after the option's expiration is worthless to the option.

If you don't want to monitor your assets continuously, you might want to avoid options. Options require you to keep a watchful eye on your assets. You want to exercise your options contract before the expiration, so you must keep a close eye on the market.

However, options are also a valuable strategy for advanced investors, who can limit their risks.

Can You Make More Money With Options Than Stocks?

Options let you multiply your money at a much higher rate than stocks. You can even generate income. Some stockholders sell call options against their stock positions to create income. These strategies are attractive and relatively low-risk in options trading.

You can absolutely make more money with options than stocks. However, you better know what you're doing. You risk a complete loss if you're wrong.