The Difference Between Stocks and Options Explained

As a rule of thumb, it is vital to understand precisely where you want to put your money before you start trading in financial markets. While many risks are involved, the returns are also handsome if you play your cards right. It’s not like online slots, for instance, where it’s all about having fun and getting lucky, as the outcomes are purely based on chance, and you might even land a seven-figure jackpot!

Stocks and options are among the most lucrative ways to make money in the stock market. Of course, owning stocks is the easiest way of investing money. However, options represent an attractive way of reducing your portfolio’s risk factor because of the good returns they offer with relatively modest capital. So, how exactly do these two forms of investment in the stock market differ? Keep reading to find out more.

What Are Options?

Options are derivative contracts that predict the future price of a given asset, and they let you bet on the direction a given asset will take. Through these contracts, you can either buy or sell an asset at a predetermined price, referred to as the strike price, within a specific period. The fee you will pay to purchase the options contract will be referred to as a premium.

To put things into greater context, if, for example, the current (September 2022) share price of Netflix goes to $218.39, then you could predict that it will rise to $230 by December 2022. So the December 2022 date, in this case, is what we refer to as the expiration date.

Types of Options

Options are widely categorized into two; call or put options. Here’s what each entails:

Call Options

Refers to when you anticipate that the underlying asset price will go up. For example, let’s say that the cost of Netflix shares stands at $218.39. You may make a call option that it will rise to $250 by January 2023. If this comes to be, then you will make money for the price increase of those shares.

Put Option

A decision you make when you expect the value of the underlying asset will go down. Going back to our example. If the price of Netflix currently stands at $218.39, you could make a put option that it will fall to $200 by December 2022. If this comes to pass, then you will make money.

Pros and Cons of Options

Investing in options has several advantages and disadvantages.

Some of the pros include:

• Easy access to leverage: With a relatively small investment in options, you could gain a large potential return.
• Are more strategic alternatives: There’s a lot you could invest in as they are a very flexible means of investment.
• Offer a lower risk: Options are less risky to invest in than owning equities and can be used to hedge a position or to produce extra income.

Some of the cons of options include:

• Expiration date: They have an expiration date which means you have a limited time for your investment to gain returns.
• High commissions: Options trading is more expensive when compared to stock trading.
• Time value decay: Since they expire, options lose value as their expiration date grows closer. As a result, some options expire with literally 0 value.

What Are Stocks?

Also known as equities, mutual funds in Canada, stocks represent proportional ownership of specific companies. For instance, let’s say a company offers 1,000 shares of stock, and you acquire 1 of those shares. With that purchase, you will then own one-thousandth of that company.

Pros and Cons of Stocks

Some of the positives you will get from stocks include:

• Stock trading is relatively easy to grasp, unlike other trading securities like options
• As a shareholder, you will receive dividends from the company you own a fraction of
• Stocks can be converted into cash pretty easily.

Some of the drawbacks of stocks include:

• Stock prices are risky and volatile. Prices may be erratic and could decline rather quickly
• Stock trading requires a lot of time as you must carry out proper due diligence
• Common stakeholders get paid last in case a company goes broke. Preferred shareholders get paid first, followed by bondholders.

Which Way Should You Go?

Having looked at what the two offer, it all comes down to a personal decision. The standard and sensible practice out there as a beginner in both stocks and options trading is to start with stock trading. This is because it is a more straightforward concept to grasp before pursuing options trading.

Here is a tabulated summary of how stocks and options measure up against each other:

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