Options and stock trading are growing in popularity among individual traders and institutional investors. However, over the years, investors have wondered whether options trading can benefit their investment more than stocks. Before you start finding the right options trading advisory service for your money, it would help if you understood each trading option’s fundamentals. This guide will explore some of the differences between stocks and options trading and help you understand how each works, what strategies you may want to pursue, and whether or not options trading is better than stock trading.
What are stocks, and how do they work?
A stock is a security representing ownership in a corporation. If you own shares of Apple, Inc., for example, you are entitled to a share of its profits and assets. The value of each stock is determined by the present and future earnings and assets of a particular firm. When someone buys shares in Coca-Cola, they hope that the company will generate more income over time to appreciate the stock value.
What are options?
An option is a contract that gives the buyer (holder) the right, but not the obligation, to purchase an underlying asset at an acknowledged price on or before a certain date in the future. The three main types of options are put, call, and straddle. An options contract is an agreement by which the option holder sells either a right or a commitment to purchase a certain underlying amount of the underlying asset.
What are the two main types of options?
The buyer (holder) of a put option agrees to sell a specific number of shares of stock at the strike price on or before the expiration date. This action is sometimes referred to as “putting the stock to someone.” This means that the put option buyer has the right to sell this stock at a price called the strike price. The seller of this option (writer of this option) is obligated to buy the stock from whoever buys the put option from him. If he cannot find a buyer for the shares, then he will have to buy that stock at its market value to fulfill his obligation.
The buyer (holder) of a call option agrees to buy a specific number of shares of stock at the strike price on or before the expiration date. This action is sometimes referred to as “calling in the stock.” This means that the buyer of the call option has the right to purchase this stock at a price called the strike price. The seller of this option (writer of this option) agrees to sell it, but only if and when (if ever) asked to do so by whoever buys it from him. If he can find a buyer for the stock, then he will sell it. If not, then he will be obligated to buy the stock at market value.
Difference Between Stocks and Options?
Stocks and options are similar financial instruments, but anyone who deals with either instrument should understand several differences between them.
The most obvious difference is the price of the same stock at which it is bought and sold. When a stock is traded on a public exchange, such as the New York Stock Exchange, its price is known to all participants in that market at all times. This public knowledge establishes the price for buying and selling shares of any particular stock. On the other hand, when an option is traded on a national or international exchange, its price is not known to everyone at all times. Only people who trade these options know the actual price of the option at any given time. It should be noted that it would be challenging and expensive for someone who wanted to buy or sell this option to establish its actual market value.
Another difference between stocks and options is that options are limited in number, but stocks are unlimited in supply. This means that if a person wants to buy a stock, he must find someone willing to sell it. If someone wants to sell shares of company stock, there is no limit on how many he can sell; there are only limits on the amount that anyone can buy within a given period. On the other hand, every option has only one buyer or seller at any given time. An option is a promise by the seller, or option writer, to sell or buy a particular stock at a certain price on or before the date in the option contract. In exchange, he is paid an option premium by the buyer of the option.
Stocks are marketable securities; that is, they may be bought and sold on any securities exchange. If you buy a single stock for $10 and sell it one hour later for $20, you have realized a gain of $10. However, if you buy an option on that same stock for $50, it is questionable whether you have realized any income at all. The value of that option has indeed increased from zero to $50. But in each year, its intrinsic worth shrinks by $50. And even if you ultimately sell the option for $100, your return on investment is still just 100% − 50% = 50%.
Advantages of Options Trading
The primary advantage of options trading is the cost-efficiency of this instrument compared to buying or selling stocks. An option has a fixed price for a specified period, while the price of a stock can change throughout the trading day. Moreover, an option does not produce income like stock, but it depends on its underlying security price movement.
Less Risk (If Used Properly)
Options trading is considered less risky than buying or selling stocks because the loss potential is low. A stock investor faces unlimited losses (if the price goes to zero), whereas an option buyer faces limited losses. The risk of unlimited losses does not exist in options trading, and the actual amount of financial loss should be limited to the amount of premium paid.
Higher Potential Returns
The higher potential return that can be made with options is achieved through time decay. This means that when an option expires, its intrinsic value will increase by the premium paid. Compared to stock, the potential for an options purchaser to earn more in the long term should be higher than those of stock buyers.
More Strategic Alternatives
Options trading gives the buyer a great deal of flexibility. If a person believes that the price of a stock will go up, he can buy a call option on that stock. This means that he has the right to purchase shares of stock at a fixed price that is known in advance. Because the option buyer does not have to purchase the stock immediately, he can take his time and wait for more favorable conditions for buying or selling stocks. This flexibility allows an options trader to develop an overall investment strategy and thus reduce risk while increasing profit potential.
So, Is Options Trading Better Than Stocks?
Investors get the best deal when it comes to options trading. This is because the risks involved in doing such are not as great as those of stock trading. Options trading requires smaller investment amounts than stocks, making it more attractive to many would-be traders. However, whether options trading is better than stock trading entirely depends on the investor’s experience with both trading instruments; some traders prefer stocks for their limitless options and market value, while others prefer options because they carry fewer risks and are cost-efficient. If you’re looking to trade with any of these instruments and need the help of a competent options trading advisory service, reach out to us at Stock King Options for more details.