Options and stocks are different ways to put your money to work; however, they offer different risks and rewards.
While stocks often offer high risk and high reward, options take it a little further, with the possibility of massive gains or substantial losses in weeks or months. They are closely related but, at the same time, significantly different. Let’s compare options vs. stocks so you can find the right investment method for you.
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What Are Options?
Options let you buy or sell a stock or asset at a specific price (strike price) during a specified period (until the expiration date). They have a fixed lifespan and expiration date, after which they cease to exist. You buy options with a cash deposit (premium), and there are two primary types: Call options and put options.
- Call options let you buy the underlying stock or asset. If the value of the stock rises, so does your option.
- Put options let you sell the underlying stock or asset. These are the opposite of call options — if the stock value drops, your option increases in value.
Generally, you buy call options if you expect prices to rise and put options if you expect them to fall.
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What Are Stocks?
Unlike options, stocks have no strike prices or expiration dates. When you buy a stock, you’re purchasing a fraction of ownership in the business that you can trade on an exchange. Stocks exist as long as the company exists.
While stocks fluctuate often, they track the business’s overall growth. So, if the company earns more, the stocks rise. But if its profits fall, so will the stock.
Options vs. Stocks: Pros and Cons
Options have a higher risk and higher reward than stocks. Both have significant benefits and distinct risks for investors.
Advantages of Options
Options come with many trading benefits.
- Trading options can result in massive returns over short periods, and with the leverage of paying a premium instead of purchasing the entire value of the option, you get a chance to turn a small amount of money into a significantly larger amount.
- While options can be riskier investments than stocks, there are many strategies you can employ to lower those risks.
- Commissions for trading options are typically much less than commissions for trading stocks.
- Options are extremely liquid — you can sell them for cash whenever the market is open.
- Taxes on options are different from those on stocks; they’re usually more favorable to the trader.
- Price volatility on options typically follows volatility in stock prices, meaning the potential gains are massive.
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Disadvantages of Options
Like with all investments, trading options have some drawbacks.
- Timing is everything with options — if the stock or asset rises after the expiration date, you don’t get anything from the price rise.
- Option prices fluctuate quickly. While this means you can profit fast, it also means that your investment could promptly decline in value.
- Depending on how you trade options, losing more than your initial investment is possible.
- You can’t hold options past their expiration date; if they expire before you make a profit, you have to take the loss.
Advantages of Stocks
While investing in stocks doesn’t usually bring as high returns as trading options, it has unique benefits.
- A diversified portfolio of stocks can potentially deliver high returns without as much risk as other investments.
- If a stock’s value drops, you can hold it indefinitely if you don’t want to sell at a loss.
- Some stocks pay dividends, giving an incentive to hold onto them.
- Most publicly traded stocks are quite liquid and fast to buy or sell.
- Investing in long-term stocks can bring some unique tax benefits.
- You can package stocks in mutual funds or ETFs for easy diversification.
Disadvantages of Stocks
While stocks have some advantages compared to options, they also have some negatives.
- Stock prices can fluctuate significantly with no guarantee they will ever reach the price you originally paid for them.
- Their prices are also tied directly to how a company performs; if a company goes bankrupt, your stock may end up being worthless.
- Analyzing individual stocks and understanding their risks and potential rewards is not an easy task.
Options vs. Stocks: Which Is Better for You?
Options and stocks are both viable ways to invest, but each one works better for different investors.
When Options Might Be Better
Options might be better for you if:
- You want to limit risk. While options come with unique risks, they also allow you to earn similar returns to stocks while investing less money upfront.
- You’re an advanced investor. If you understand options strategies and how to limit your risk, options can bring substantial returns.
- You want to generate income. If you hold stocks, you can sell call options against your positions or create put options to create income in a relatively low-risk way.
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When Stocks Might Be Better
Stocks might be better for you if:
- You want a long-term investment. Stocks can grow a lot over the years, but you have to sit through downturns and keep your money in the market.
- You have less experience. Stocks require lots of work and analysis, but not as much as options. Plus, mutual funds and ETFs make for relatively simple beginner investments.
- You don’t like following the market. While stocks require some market monitoring, it’s less work than options that expire on a specific date.
Considering Investing in Options? Start Here
Options are a more tactical approach to investing, require less upfront capital, and have flexibility regarding downside risks and timing.
However, options do add complexity to the investing process. Buying stock means betting that the price will rise, while trading options means you have to make more decisions — What direction will the stock go in, how high or low will it move, and how long will that movement take?
Luckily, you have options for options. Learn how we make options trading easy.
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