Options vs. Stocks: Which Is Better For You?
Stocks and options have one thing in common - both can be very lucrative to trade. That being said, they’re not the same, and it’s vital to know key differences between stocks and options before you decide to invest your money in either. In this article, we’ll explore those differences and highlight the potential benefits and disadvantages.
Defining Stocks and Options
Stocks provide access to ownership of shares, while options offer the individual the chance to buy contracts during a set period for a specified price and make money by betting on the future value of stocks. The key difference between stocks and options is that when you buy stocks, they represent a share of a company or organization.
Options are agreements with investors, which allow you the opportunity to bet on what you think is going to happen to the price of stocks. It’s possible to invest in both stocks and options, but one avenue may suit you better than the other.
What Are Stocks?
When you purchase stocks, you gain ownership of a slice of the company or business, and your primary goal is to try to buy at a low price and sell for a higher fee. If you achieve this objective, you’ll generate profits in the form of capital gains. If you invest in stocks and you take ownership of the decision-making process, you can choose where to spend your money.
With stocks, there is also an opportunity to take advantage of dividends. Some organizations will pay shareholders a dividend as a perk of owning the stock. In most cases, dividends are paid annually or quarterly. Stocks don’t have a finite expiry date and will continue to exist as long as the organization trades.
What Are Options in Stocks?
Options, sometimes known as stock options, offer individuals the opportunity to buy or sell stocks at a specific time for a set price. You don’t gain ownership of any part of the company and will not receive dividends. Unlike stocks, options do have a finite lifespan. The expiry date will be predetermined, and once the deadline passes, the value of the options will be divided among investors.
There are two main types of options available. Buyers who wish to purchase a contract pay a premium. Once payment is completed, the investor takes ownership of the options contract. The two types of options are:
- Call options, which offer the right to buy stocks at a specified price before or on the agreed deadline
- Put options, which give you the right to sell stocks at a specified price during a set time period. If the stock value decreases, the put option will appreciate in value.
What’s the Difference Between Stocks and Options?
High reward potential
Very high reward potential
Very high risk
Equity investment (the investor gains ownership of a portion of the company)
Derivative investment (investors don’t gain ownership of a slice of the company)
Infinite lifespan (unless the company ceases trading)
No commission fee with most high-profile online brokers
Commission fees vary according to the broker and are usually around $0.65 per option contract
Trading possible whenever the market is open
Trading possible whenever the market is open
Liable for capital gains tax (can be either short-term or long-term depending on the duration of trading)
Liable for capital gains tax
Suitable for long-term and short-term investors
Suited to short-term investors
How Does Options Trading Work?
Options trading is more complex than buying and selling stocks. When you invest in stocks, you buy stocks and hope to sell them at a later date at a higher price. When you buy options, there are time frames to consider, which increases potential risks.
Before we delve deeper into the world of options trading, it’s beneficial to outline key terms that’ll crop up frequently when exploring options trading possibilities. These include:
- Strike price - the agreed price at which the holder can either buy or sell
- Expiration date - the date on which the contract expires
- Option premium - the fee you pay to secure an options contract
When you invest in call options, the expectation is that the value of the stock will rise above the strike price so that you can buy at a lower price and sell at a higher one.
When you invest in put options, you want the value to drop so that you can profit from the difference between the strike price and the new value.
Pros and Cons of Stocks
Stocks offer benefits for both experienced investors and novices, but there are also potential drawbacks and pitfalls.
Advantages of Investing in Stocks
- Stocks have the potential to deliver substantial returns with lower risks than options.
- The lifespan is infinite, meaning that individuals can make long-term investments.
- Investors can take advantage of additional income through dividends.
- Investors can benefit from acquisitions in which companies are bought for prices far higher than the market value.
- Trading stocks is generally inexpensive, as most online brokers charge 0% commission.
- Investors can trade at any time when the market is open and exchange assets for cash.
- There are possibilities to capitalize on capital gains tax relief for long-term investments. If you plan to hold onto your stocks for at least a year, you could save money on taxes.
- Stocks can form part of a diverse investment portfolio, as it is possible to combine them with exchange-traded funds or ETFs.
- Stocks are suited to both passive and active investors.
- The process of investing in stocks is relatively simple, making it accessible to beginners.
Disadvantages of Investing in Stocks
- The prices of stocks vary, and the market can be volatile. It’s never guaranteed that you’ll be able to sell stocks for a higher price than you bought them.
- There is a risk of losing money through stocks because they’re not guaranteed by the government.
- Not all companies will grow, expand, and flourish. Stock prices tend to reflect the performance of the organization, so it’s critical to back the right businesses.
- Investing in stocks requires rigorous research, which can be time-consuming.
- Investors will have to pay taxes on profits.
- Market movements may mean that it takes time to see stock value increase or recover, making stocks a better option for long-term investors than individuals looking to make money quickly.
Pros and Cons of Options
Just as there are pros and cons of stocks, there are advantages and drawbacks of options.
Advantages of Investing in Options
- Potential to benefit from extremely high returns in a short space of time.
- Volatility increases risks, but it also creates opportunities for investors to grow their investments rapidly.
- Commission fees have come down and there are some online brokers that offer free options trading.
- Investors can trade options for cash whenever the market is open.
- Profits are taxable, but there are ways to save on capital gains tax when securing options contracts that expire after a year.
Disadvantages of Investing in Options
- Options trading is high-risk.
- Prices can rise or drop suddenly, leading to significant losses.
- Options are not guaranteed by the government.
- Profits are not guaranteed: You may end up making a loss.
- Options have an expiry date: You can’t benefit from price changes once your contract has expired.
- Options trading tends to be more expensive than investing in stocks due to commission fees.
- Options are not generally suited to investors looking to package investments in EFTs.
- The process of investing in options is more complex, meaning it’s not ideally suited to beginners.
Options vs. Stocks: Which Is Best for Me?
Both options and stocks can provide significant benefits for investors, but in many cases, one will be more suitable than the other. When comparing option trading vs. stock trading, it’s important to tailor your decisions based on your circumstances, experience in investing, and how much time and energy you want to devote to your investment.
When To Invest in Stocks
Investing in stocks may be better for you if the following criteria apply:
- You are looking to invest in the long term.
- You have some experience in stocks and shares, and you understand how the market works.
- You are happy to adopt a hands-off approach to investing.
- You are looking for an inexpensive way to get started or build your portfolio.
- You don’t mind devoting time to researching companies to increase the chances of buying the right stocks.
- You would prefer a simpler way to invest.
- The market is volatile. (If the market is volatile, stocks can present a better opportunity than options, as you can ride out the lows and capitalize on the highs, which may not be possible with options due to expiry dates.)
When To Invest in Options
Options trading may be the best choice if the following criteria apply:
- You’re an experienced investor with in-depth knowledge of the market and how options trading works
- You’re looking for an opportunity to increase your income significantly in a short space of time
- You want to explore the possibility of buying stocks at a better price
- You want to assume an active role in investing
When looking into stock or options markets, it’s wise to weigh up the pros and cons and consider your individual circumstances and objectives.
The Bottom Line
Stocks and options both offer investors the opportunity to make money, but there are key differences between them. It’s crucial for investors to understand how options and stocks differ and compare the advantages and disadvantages before making a decision.
There is no universal answer to the question, “Are options better than stocks?” and it’s important that each individual investor takes the time to research and weigh up the pros and cons.
Are options better than stocks?
For some investors, options may be better than stocks, but this is not always the case. Options are usually riskier than stocks, and the process can be more complex and expensive. Options may be better than stocks for investors looking to grow their money rapidly.
Are options harder than stocks?
Options trading is more complicated than buying and selling stocks because there’s an expiry date and set prices (the strike price) to take into account. This type of trading is best suited to more experienced investors.
Why is trading options a bad idea?
Trading options may be a bad idea for beginners and those unfamiliar with the market and how options trading works. It might also be unwise to opt for this type of investment if you’re more interested in long-term investments, or you don’t want to run the risk of losing a lot of money in a short space of time. Buying stocks is often a safer option for long-term investors.
How are options different from stocks?
One of the key differences between options and stocks is that when you buy stocks, you take ownership of a slice of the company. Within options trading, you buy a contract, which gives you the right to buy or sell within a specified time frame. Investors can also benefit from dividends when purchasing stocks, and there is no limit on the lifespan of the stock, provided that the company continues to trade. If you buy options, you’ll need to take action before or on the expiry date, which increases the risk.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.