One of the most common questions I get asked is whether trading options vs. stocks, which are a better investment. While there are pros and cons to both, I generally prefer options for a few reasons.
Options and stocks are two ways to put money to work in the market. However, they offer different profiles for risk and reward. Stocks offer high-risk, high-reward potential, while options take that a couple notches higher, with the possibility to double or triple your money (or more) at the risk of losing it all. This often occurs in a matter of a few weeks or months.
So, Which Is better?
It depends on your investment goals and risk tolerance. If you’re the type of investor who is looking for quick, high-reward trades, then options might be the way to go. However, if you’re more interested in a slow and steady approach with less risk, stocks might be a better choice.
Ultimately, the best way to find out is to experiment with both options and stocks and see which suits your investment goals and style the best.
Differences Between Stocks and Options
Stocks and Options
A stock is a collection of shares that signify ownership in a company. When you buy a share of stock, you are buying a piece of the company. For example, if Company XYZ has 100 shares outstanding and you own one share, then you own ____% of Company XYZ.
An option is a contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a certain date. An option is like an insurance policy for your stock portfolio; it protects you from losses in the market while still allowing you to participate in upside potential.
Two Types of Options
There are two types of options: call options and put options. A call option gives the holder the right to buy an underlying asset at a specified price, while a put option gives the holder the right to sell an underlying asset at a specified price.
In the sections below, I will discuss why I choose options vs. stocks.
1. Stock Prices Fluctuate, Significantly, From Year to Year
When you buy a stock, you are buying a piece of a company that will (hopefully) increase in value over time. However, stock prices can also go down, meaning you may not be able to sell a stock for any given price or even what you paid for it.
With options, you are buying the right to purchase or sell an asset at a certain price, but you are not obligated to do so. This means that your potential losses are limited to the premium you paid for the option, and you still have the opportunity to participate in any upside potential.
2. Options Require Less Capital
With options, you can control more shares of a stock with less money. This gives you more exposure to the stock without having to put up as much capital. This allows you to make bigger profits with less risk.
In comparison to stock trading, options also offer more flexibility when it comes to strategies. For example, with stocks, you are limited to buying or selling. With options, you can also write (sell) options, which gives you the potential to earn income from your options positions.
Options give you the ability to profit in both rising and falling markets. When you buy a stock, you can only make money if the stock goes up. But with options, you can make money if the stock goes up, down, or even sideways.
A premium is the price of an option contract. When you buy an option, you pay a premium. This is the price you pay for the right to buy or sell shares of the underlying stock at a specified price.
Selling options is a great way to generate income. There are a variety of strategies that allow you to sell options and collect the premium as income.
In terms of stock and options, with options, there are a variety of positions that you can take depending on your investing style and goals.
Long Call Options Trading
One common position is the long call. With this position, you buy a call option with the hope that the stock will go up in price. If it does, you can sell the call option at a profit.
options trading vs. stocks
Call options are a type of options contract that gives the buyer the right, but not the obligation, to buy shares of the underlying stock at a specified price (the “strike price”) within a certain time period.
When you buy a call option, you’re hoping that the stock will go up in price so that you can sell it at the strike price and make a profit.
If the stock does go up, you can exercise your option and buy the stock at the strike price. You can then sell it immediately for a profit. If the stock doesn’t go up, you can let the option expire worthlessly and lose only the premium that you paid for the option.
Covered Call Options Contract
One strategy is called the covered call. With this strategy, you sell a call option against shares of the underlying stock that you already own. This will generate income for you, regardless of whether the stock goes up or down.
If the stock does go up, the call option will be exercised, and you’ll have to sell your shares at the strike price. But, since you already own the shares, you’ll just be selling them at a higher price than you paid for them. This will give you a profit.
If the stock doesn’t go up, the call option will expire worthlessly, and you’ll get to keep both the premium and the shares.
Long Put Options Trading
Another common position is the long put. With this position, you buy a put option with the hope that the stock will go down in price. If it does, you can sell the put option at a profit.
Put options are a type of options contract that gives the buyer the right, but not the obligation, to sell shares of the underlying stock at a specified price (the “strike price”) within a certain time period.
When you buy a put option, you’re hoping that the stock will go down in price so that you can sell it at the strike price and make a profit.
If the stock does go down, you can exercise your option and sell the stock at the strike price. You can then buy it back immediately for a profit. If the stock doesn’t go down, you can let the option expire worthlessly and lose only the premium that you paid for the option.
In sum, options provide flexibility that stocks don’t. You can tailor your options position to fit your own investing style and goals. In addition, there are a variety of strategies that allow you to sell options and collect the premium as income.
These are just a few of the many ways that you can trade options. There are also more complex positions that involve multiple options contracts. These positions can be used to hedge your portfolio or generate income.
3. Options Offer Ability to Hedge Against Volatility
Finally, options allow you to hedge your portfolio against risk. If you own a stock that you’re worried might go down, you can buy a put option to protect yourself.
Volatility is a measure of how much the price of an asset fluctuates over time. A stock with high volatility will see its price rise and fall very rapidly, while a stock with low volatility will see its price change more slowly over time.
Options are more sensitive to changes in volatility than stocks, which means that they can be more profitable in a shorter time frame. However, this also means that options are riskier than stocks and can lead to greater losses if the market doesn’t move in the direction you expect.
Hedging is a technique used to reduce risk by taking opposite positions in the same security. For example, if you own a stock that you’re worried might go down, you can buy a put option to protect yourself. This will limit your losses if the stock does go down.
Disadvantages of Trading in Options
Of course, there are also some downsides to options that you should be aware of before you start trading.
- When trading stocks, you must be correct not only in your investment strategy, but also in the timing of your investment. A stock that rises after an option’s expiration is meaningless to the option.
- Trading options rather than stocks can be a more volatile investment. Prices can fluctuate significantly from day to day, and price moves of more than 50 percent are quite common, meaning your investment could decline in value quickly.
- Options are not guaranteed by the government, so you can lose money on them.
- Depending on exactly how you use options, you can lose more than you invest in them.
- Options expire, and when they do, the opportunity to trade them is over.
- Options can expire worthless.
But overall, still, I believe the pros of options trading outweigh the cons.
Summary: Trading Options vs. Stocks
Options trading can be a great way to meet your investment goals. This lesson has reviewed a few reasons why I prefer trading options over stock trading.
There are a variety of positions that you can take depending on your investing style and goals. These positions include long calls, long puts, and many more strategies.
Options trading provides flexibility that stocks don’t, and you can tailor your options position to fit your own needs. Just make sure that you understand the risks involved before you start trading.
If you’re interested in learning more about stocks and options, Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, options trading methods, and trading courses. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
Feel free to check out other FREE educational resources to help guide you as you begin your new journey to financial freedom.
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