Options Vs. Stocks Trading: Which One Is Better For You?

Stock trading and options trading are different ways to make money in the market. Stock trading involves buying and selling ownership stakes in a company. Options trading involves making bets on the future price of a stock. Let’s explore more about each to know further:

What are the Options?

An option is a financial instrument that represents the right to buy or sell a particular security. An option specifies a pre-determined price at which the security can be purchased or sold and a pre-determined expiration date, after which the option is worthless. An option is a derivative security because it derives its value from an underlying security such as a stock.

Options trading requires investors to decide the following three things:

What direction the stock is headed.
How high or low it will move from its current price?
The time frame in which that will happen.

Types of Options

Options are broadly classified into:

Call Options – A call option gives the holder the right, but not the obligation, to buy certain security at a predetermined price on or before a predetermined date. Investors buy calls when they believe the price of the underlying asset will increase and sell calls when they believe it will decrease.

The buyer of a call option pays the option premium in full at the time of entering the contract. Afterward, the buyer enjoys a potential profit should the market move in his favor. There is no possibility of the option generating any further loss beyond the purchase price. This is one of the most attractive features of buying options.

Put Options – A put option gives the holder the right, but not the obligation, to sell a certain security at a predetermined price on or before a predetermined date. Investors buy puts when they believe the price of the underlying asset will decrease and sell puts if they believe it will increase.

A put option gives the buyer the right to sell the underlying asset at the option strike price. The profit the buyer makes on the option depends on how far the spot price falls below the strike price. If the spot price is below the strike price, then the put buyer is “in the money.” If the spot price remains higher than the strike price, the option will expire unexercised. The option buyer’s loss is, again, limited to the premium paid for the option.

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Application of Call and Put Options

Calls and Put options are primarily used by investors to hedge against risks in existing investments.

Hedging: Buying Put Options – If an investor believes that certain stocks in their portfolio may drop in price but they do not wish to abandon their position for the long term, they can buy put options on the stock. If the stock does decline in price, then profits in the put options will offset losses in the actual stock. This is a common practice during the earnings seasons of companies.
Speculation: Buy calls or sell puts – If an investor believes the price of a security is likely to rise, they can buy calls or sell puts to benefit from such a price rise. Their potential profit is limited to the premium received for writing the put. Their potential loss is unlimited – equal to the amount by which the market price is below the option strike price, times the number of options sold.
Speculation: Sell calls or buy puts on bearish securities – Investors can benefit from downward price movements by either selling calls or buying puts. The benefit this provides to the trader writing the call option is the option premium. Whereas, the trader buying the out options has a potentially unlimited upside but a limited downside, equal to the option’s price. If the market price of the underlying security falls, the put buyer profits to the extent the market price declines below the option strike price. If the investor’s hunch was wrong and prices don’t fall, the investor only loses the option premium.

Pros and Cons of Options

It is always best to know about the possible pros and cons of any investment traders plan on doing. Let’s discuss the benefits and disadvantages of the options:

Pros

Lower Upfront Financial Commitment – Options trading is highly profitable due to its considerable leveraging power. The money invested upfront is lower than what a trader would spend while purchasing stocks.
Greater Flexibility When Trading – Options offer traders greater flexibility when trading. This enables them to invest better against their existing investments. The different types of strategies while trading options include:
Exercise the option to buy shares and consequently sell all or some of them.
Exercise the option to buy shares and add them to your existing portfolio.
Sell your profit-making options to another trader.
Possibly earn back some money by selling a loss-making option to another investor before the contract’s expiry.
Reduced Risk – Traders can adapt the trading strategies of options to reduce risk. This can be done by limiting the exposure to loss vis hedging.
Greater possible returns – Options are typically available at a lower margin but still yield a greater potential return on investment.
Fix a stock price – Options let traders choose a specific price for a certain duration that aligns well with their trading requirements.

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Cons

Complex Rules – Options trading usually has a certain set of complex rules that traders must understand and adhere to. It is very important to understand the way options work before starting trading
Traders Must Meet Specific Requirements – There are a certain set of requirements that a trader must meet to be approved by a broker to start options trading.
Limited Time – Options trading profits from the short-term price movements that happen within days, weeks, or months. Therefore, traders have to pick the perfect time to buy an options agreement and pick the best time to sell, exercise, or walk away from one before its expiry. But determining this is often complicated due to the shorter duration within which traders must make this decision.

What is Stock Trading?

Stock trading is the act of buying and selling stocks—pieces of ownership in public companies—on a stock exchange. Stock traders aim to make money on price changes of the stocks they buy and sell.

Types of Stock Trading

There are different types of trading based on the difference in strategies used:

Day Trading – Traders buy and sell the securities on the same day. Day trading requires advanced knowledge, expertise, and full-time devotion to the share market. The traders earn or lose from the market fluctuations and leave the market at the end with either a profit or a loss.

Position Trading – Position trading usually portrays a long-term trading strategy resembling buy-and-hold investing. A trader buys and holds shares for a larger period, like weeks or months, ignoring the short-term fluctuations.

- Swing Trading – Swing trading is a form of speculative trading seeking the right opportunity to gain from price swings. Swing traders hold securities for a day or more based on fundamental and technical analysis but not for long-term periods.

Scalping – The scalping strategy focuses on reaping small profits from small price fluctuations continuously. For instance, they may complete 10 to 100 trades in a day. The success of the scalping strategy significantly depends on the appropriate selection of entry and exit points.

Pros and Cons of Stock Trading

Every type of investment has its type of benefits and disadvantages. It is always advisable to know all the sides of trading before jumping in. Let’s discuss the pros and cons of stock trading:

Pros

Capital appreciation – Profit from capital appreciation is one of the prime sources of profit from stock trading
Low cost of trading – Many brokers today have reduced trading commissions to zero, so it’s cheap to buy and sell stocks.
Historically, it has been proven that capital price appreciation is higher than inflation. Therefore, investment in stocks can beat inflation.
Dividends – As shareholders, investors will receive dividends from any company that pays them.
Indefinite holding period: There is no limit to how long investors can hold their shares. They can easily hold for a year or longer and only pay the long-term capital gains tax rate on any gains.
Low cost of entry: Many brokers will allow you to buy fractional shares of stock for as little as $ 1 or $ 5.
Bonus issues: This is free shares given to existing shareholders of a company. Sometimes, the company declares a bonus instead of a dividend or both.

Cons

Share price crashes – Due to multiple factors, share prices have the tendency to drop by a good percentage in a single day leading to huge losses.

The threat of liquidation – When companies declare bankruptcy, investors can lose all of their money invested in the companies stocks.

Stock prices depend on the performance of the company. Therefore, choose the companies wisely.
Stock Market is very volatile. There is no guarantee of profit.

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Difference between Stocks and Options

	Stocks	Options
May be a good fit for	Beginners and long-term investors	Active traders who want flexibility
Potential drawbacks	Risks, fees, and taxes	Effort, additional risk, and cost
Type of investment	Equity	Derivative
Risk Level	High	Very High
Time Duration	Potential life-long investment	Limited

The biggest difference between options and stocks is that stocks represent shares of ownership in individual companies. Whereas, options are contracts with other investors that allow traders to bet on an expected future price of the company’s stock.

Stock trading is simple and easy. It only requires opening an account with a broker and start trading. Stocks can be held for long term which have been proven to yield a good return. Therefore, stock trading is an excellent option for beginner traders and investors wanting to invest for the long term. Whereas, options trading is complex. Traders need to have a good knowledge of the market to understand where the stock is heading, how high or high low the stock will go, and during what time frame. This type of trading is best suited for active traders.

Stock trading comes with its risks, fees, and taxes on capital gains and dividends. On the other hand, options trading requires more effort and is comparatively riskier.

Stock trading comes with the option for long-term investing. It’s the trader’s choice for how long he/she wants to invest. They can invest for a day for a lifetime. Whereas, options are a time-bound contract. Investors have to execute the trade within the agreed-upon time duration.

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Stock vs. Options: Which is better for you?

Stocks and options both are viable and good investment options. However, each works better in different scenarios:

Situations when the stock trading is better:

Stock trading requires analysis and a good understanding of the market to benefit from the trade. Therefore, as an investor when you feel you have a good amount of understanding of the market, you can start stock trading.

When long-term investment is the goal. Stocks can rise by a good percentage over the long term which means stock trading is a profitable long-term investment option for the relevant investors. But sometimes they have to experience downturns too.
You cannot vigilantly follow every trade. While stocks require a good amount of investor time, they are less time-consuming than options trading.
The stock market is volatile. If you believe in a stock long term but it’s volatile, it’s easy for options to expire worthless. Stock gives you a permanent stake, but you’ll have to ride out the ups and downs, and you can’t do that with options.

Situations when options trading is better:

Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk within certain bounds.
Options trading is useful for advanced investors. Experienced investors know how to limit their risk and they understand the risks they’re running when they use a given options strategy.
Traders are willing to take a higher risk. Options offer a good and sometimes very high return on investment. But the risk is also equally high. Therefore, it’s only suitable for risk-takers.
Options can allow you to generate income. Some stockholders sell call options against their stock positions or write put options as a way to create income. Such strategies can be attractive and relatively low-risk ways to use options.

CONCLUSION

Stocks and options offer a completely different return and risk portfolio for investors. Investors interested in investing in either should understand how they work before getting involved. Beginner investors and those who prefer simplicity generally will stick to stocks for their straightforward nature. Those who favor an active investment approach and love to watch the market may find options appealing.

Nevertheless, deciding which is a better option is entirely a personal decision, based on the investor’s investing style.