Trading Options vs Stocks
2022-04-11 | Simpler Trading Team
Have you ever been to a restaurant to have a meal, but when you get there, you are unsure what to order? You may be indecisive about eating beef or chicken. However, despite the menu having various options, not all meals will suit your appetite.
Similarly, when deciding between stocks or options, or even combining both, your decision should be informed by several factors such as position sizing, risk tolerance, goals for trading, and the timelines you have. While it is easy to pick stocks over options, building your portfolio with options trading would be wise. Nevertheless, your investment knowledge will help you make significant trading decisions, and this article will help you with informative insights to help you decide which is best for you.
What are the Differences between Options and Stocks?
When you have fundamental knowledge about options and stocks, you will know their differences, benefits, and disadvantages to decide the type of trading that fits your investment style the best.
What are Options?
Traders know that the path to earning profits in the market is buying stocks, holding and selling them later at higher prices. However, when dealing with options, it is not that easy because options contracts have an expiration date, unlike stocks. Beginner traders can incur unexpected losses without knowledge of how options contracts work.
Options contracts let you trade stock without actually purchasing the stock. For example, if you think a stock is going up, you would buy a call option. A call option gives the buyer the right to purchase the stock at a specified price, but not the obligation. Alternatively, the option buyer can just sell the option contract as it gains value, never actually owning the stock. As another example, if you think a stock is going down, you would buy a put option. A put option gives you the right to sell someone a stock at a specified price, but they are not obligated to do so. But the option holder could also just sell the options as the stock goes down and the put option gains value. . Traders tend to choose options to hedge risk, speculate, and earn income. Traders can use brokerage investment accounts such as thinkorswim, TradeStation, and tastyworks to purchase options like other asset classes.
What are Stocks?
Traders buy stock shares to own a small percentage of a company. When traders purchase stock shares, their goal is to buy low and sell high. As a result, stock traders will earn profits referred to as capital gains. Stock traders can also make additional profits because some companies pay shareholders dividends on a monthly, quarterly, or annual basis.
Options vs Stocks Video Guide
Factors to Consider When Investing in Stock and Options
Both options and stocks are viable investment decisions. However, they work best for traders in different scenarios.
To be successful in stock trading, you should have some knowledge of the stock market. Successful stock traders have experience. Options trading requires more experience than stock trading. Therefore, stocks offer better choices for beginners and intermediate traders.
Stocks and options both have long and short-term holding times. However, options contracts have expiration dates and stocks do not. As options contracts near their expiration date, they lose some of their value. So you can buy stocks and hold them for 1 day, 1 year, or 10 years without an expiration date. On the other hand, you can buy options that might expire in 1 day, 1 month or 1 year. With Options, it’s imperative to understand the conditions in the contract, so you can trade accordingly.
Effort and Time
While you need to monitor the stock market from time to time, options trading requires traders to follow the market more closely because they expire on fixed schedules. Stocks are a much more passive way to participate in the market. Stocks still hold risk in that companies can fail and market conditions can hurt company performance. Options take more babysitting because they do expire and you may need to take action before expiration.
The long-term nature of stocks reduces the risks of losing the total value of stocks compared to options, which can be worthless upon expiration.
With options, traders can still earn stock-like profits while investing less capital and limiting their risk.
Differences between Options and Stocks
While investing in either options or stocks can be profitable for your investment portfolio. All investments and trading have potential drawbacks and benefits which traders must consider before making investment decisions. Traders who prefer trading options over stocks might be enticed by the advantages and opportunities options trading offers.
Below are the Advantages of Options over Stock Trading
- Options are more flexible than stocks: As a trader, options allow you to decide if and when to exercise the call or put option or simply sell it back to the market when it gains or loses value.
- Profit and loss predictability: since options buyers and sellers decide the strike price, you have an advantage of gauging your profits or losses when you exercise your options strategy.
- Compared to stock trading, options trading allows traders with limited capital to participate in the market as they don’t tie up much capital.
- Possible hedge against volatility.
- Traders have greater potential returns
Similarly, traders should consider the possible downside of options trading over stock trading.
Disadvantages of Options Trading over Stock Trading
- Greater potential for loss: when you invest in options, you bet that stock prices will move in a particular manner within a specified amount of time. If you make a wrong assumption about the stock price movement, or when buying or selling timing is incorrect, you will lose money.
- Traders’ risk of loss is higher.
- More effort is required.
- Best for more knowledgeable traders, active and advanced traders, therefore, discouraging beginners.
- Limited lifespan: Options contracts run for a limited duration, weeks or months, and a maximum of approximately two years for publicly traded options.
Trading Stocks Vs Options
The life span of stocks is indefinite as stock trading will continue as long as the issuing company remains publicly traded and does not go bankrupt. The stock value can fluctuate significantly on an annual basis, but the stock performance should represent the company’s growth. When the stock issuing company increases its earnings, the stock value will appreciate over time. However, a fall in profits will cause the stock value to depreciate. The stock will cease existing if the stock issuing company goes bankrupt.
Below is a list of advantages and disadvantages of stock trading over options trading:
Advantages of Stock Trading
- Trading stocks have lower investment risk than trading options.
- Trading stocks have a higher life span, potentially infinite lifespan.
- Lower potential upside compared to options that have a very high and quick potential upside.
- Buying and selling stocks are cheap because stock trading has no brokerage commission fees at major online brokers.
- Some stocks pay dividends annually. Since most stocks increase their dividends annually, traders receive more returns over time.
- The stock shareholders get higher rewards if the stock issuing company is acquired at a premium to its actual market value.
- Publicly traded stocks have high liquidity since traders can convert them to cash on any market day.
- Stocks can be packaged in mutual funds or exchange-traded funds, allowing traders to quickly and cheaply invest in a diversified portfolio.
Disadvantages of Stock Trading
- Annual stock price fluctuations
- Stocks are not government-guaranteed, so traders risk all their money if they choose the wrong individual stocks.
- The future of the stock prices depends on the growth and performance of the company. Therefore, Traders must-own stocks of companies with potential growth.
- Researching individual stocks analytically and technically only to understand whether they are risky or an opportunity is time-consuming and complicated.
Day Trading Options Vs Stocks
Is Day Trading Options Better Than Day Trading Stocks?
Low-cost strategy: compared to day trading stocks and other securities, options day traders have the flexibility to enter or exit positions with less risk quickly. Buying options can be significantly cheaper than buying individual stock shares.
Diversity: Since trading options can be cheaper than investing in the actual stock; day trading options allow traders to diversify their capital on other trading opportunities.
More incredible benefits: options day trading is more beneficial than stock day trading because day trading options can gain value faster than the stock itself. Additionally, there is added protection to options. For example, if the option isn’t profitable, then the buyer does not have to exercise it.
Options Vs Penny Stocks
Penny stocks tend to be more appealing to beginner or novice traders as opposed to options. Penny stocks can generate higher returns in the short term in addition to being cheaper. But, penny stocks are still very risky and a lot of research needs to be conducted. Options, on the other hand, sound riskier and more complex, thus attracting seasoned investors and traders. Below are some other reasons why penny stocks are preferred to options trading.
Options require loads of knowledge, whereas you only need to be right about direction and are not required to pinpoint accurate time frames for penny stocks.
Most brokerages take advantage of the complexity of options to charge higher transaction costs, whereas penny stocks’ transaction costs are cheaper.
Margins to trade options are frequently higher than penny stocks. Whereas in most cases, options are a derivative of a company, penny stocks are like pipe dreams; thus, manipulation and hype are much higher for penny stocks than for options.
Swing Trading Options Vs Stocks
Swing trading is considered one of the most popular forms of trading. It involves looking for short to medium-term gains in a stock. It can last for a few days to a couple of weeks. Price action movements play a key role in helping swing traders take profits or losses. Swing traders are exposed to abrupt overnight changes in price between sessions.
Though closely related, there are many differences between stocks and options, particularly regarding the amount a trader can make or lose. The following are the critical comparisons between swing trading options and stocks:
- Time of trading: You can trade anytime as long as the market is open.
- The risk involved: The risk involved in swing trading options is higher than the risk for stocks.
- Taxation is highly dependent on capital gain rates and holding periods on a short-term or long-term basis.
- Brokerage commissions: For swing trade options, commissions are charged at $0.65 per contract, but often there are no commissions for stocks at major online brokers.
- Lifetime: Swing trading options are limited to weeks or months, but stocks can be infinite.
Stock Options Vs Forex Trading- Why Forex Trading Is Better
Compared to all other markets, such as stock options, the forex trading market is open longer – 24 hours five days a week, offering traders unlimited time to trade. Forex trading allows traders to take advantage of the market whenever global events happen.
With forex trading, traders receive immediate trade executions because there are no delays like trading options and other securities. Forex trading eliminates guessing the best prices as orders are completed at the maximum prices. Forex trading has more liquidity, avoiding order slippage as in options trading.
Forex traders save more money than options traders because there are no commissions and brokerage fees like in options trading, where the trader must work with brokerage companies.
With forex trading, traders are assured of limited risk because the forex trading system automatically initiates margin calls when margins rise more than the account value. With options, traders have limited time before they expire.
Overall, options and stocks offer traders different risks and returns. Trading either of the securities requires traders to be informed and knowledgeable to understand how they work before getting involved. Make no mistake to assume the advantages and disadvantages of either trading options or stocks because you will either become more prosperous or poorer trading any securities.
FAQs on Stocks and Options
Q: How to scan stocks on thinkorswim?
A: You can scan stocks on thinkorswim using the Stock Hacker tool.
Q: How do you take a long position on a stock?
A: To go long on a stock you have to obtain an account from a brokerage firm where you will have the ability to buy stocks.
Q: What is the difference between short and long positions in stocks?
A: Going short means that you think the stock is going to trade lower. It occurs when you borrow a stock and sell it on the open market, planning to buy it back later for less money. Going long quite simply means that you purchase the shares of the stock outright.
Q: What is difference between European and American option?
A: Traders can only exercise a European style option at its expiration date while American options can be exercised at any point before the expiration date.
Q: Can I start options trading with $500?
A: Yes, you can start trading options with $500. To trade options you need a brokerage account. Most brokerages don’t have account minimums.