Searching ‘stocks and options‘ on Google yields about 288 million results. This tells us that both of these financial markets are insanely popular. Whether you’re on YouTube, Facebook, Twitter, Instagram or any other online community, you’ll find someone talking about stocks or options.
The average person can provide a basic definition of what a stock is. But options are a bit more complex to understand. You’d be hard-pressed to find many people who can differentiate between stock trading vs options trading.
If you had questions like ‘can you trade stocks as options’ or ‘are options better than stocks,’ we have you covered here.
(If you like forex and want to know the difference between that and options, check out this guide here).
What are stocks?
Let’s look at the first part of our stock trading vs options trading discussion. A stock or shares is an instrument allowing you fractional equity of a listed company. It’s a method for corporations to raise funding from investors in return for giving up equity in their business.
Most shares are traded through an exchange (but you can trade some through a broker or privately). This is the same premise when looking at option trading vs stock trading. The listing of shares follows a pattern like this:
- It starts with a company that has a proven multi-year profit track record. They use the stock market as a means to generate more capital to raise their bottom line and profile.
- The corporation will need to meet the requirements from their chosen exchange to get listed. During this time, they decide how much of their business they will sell as shares, each of which are priced at a certain value.
- The company will have an initial public offering (IPO), an event where the stocks get listed publicly for the first time.
Investors can decide to buy or sell the stock at this stage or later based on various technical and fundamental elements.
When selling, you make a profit when the stock is doing poorly. Conversely, you can also make money if you’ve bought a stock that ends performing well.
Aside from the natural price appreciation, some equities pay yearly dividends, which are a portion of a company’s profits. This represents one of the major differences when looking at stock trading vs options trading.
What are options?
Now let’s look at the second of our stock trading vs options trading conversation. An option is a type of financial derivative where you have the right (but not the obligation) to buy or sell a specific market at a certain price and expiry date.
In simple terms, you have the privilege to buy or sell but aren’t obligated to hold what you’ve bought or sold. The only price you pay is a premium if your prediction is wrong.
Options trading is like wagering or betting the value of an asset will be below or above a certain level (the ‘strike price’) within a set time limit.
The latter is the expiry date, which ranges from one minute to a few months depending on the type of option and where it’s traded.
There are many types of options, including exotic types like binary, no/touch, straddle, butterfly and ladder, among others. Yet, the most popular and accessible are call and put options (collectively referred to as vanilla options).
A call is where you bet a market’s value will be above the strike price, while a put is where you bet a market’s value will be low the strike price.
Stock trading vs options trading: similarities and differences
There are some comparable aspects when looking at stocks and options:
- Trading venue: Traditionally, we trade shares and options on exchanges. We can also speculate in either market as a derivative via a broker.
- Risk: Any financial asset carries the potential of monetary loss, which can be emotionally or psychologically challenging. Some argue that options are riskier, but it depends on where you trade them.
The risk is higher if you’re using more leverage, which is only possible from a broker than an exchange.
Let’s look at the differences between stock trading vs options trading. We have summarised them in the table below, before going more in-depth.
|Ownership||Equity in a company||No equity|
Perhaps the most significant distinction as we explore stock trading vs options trading is ownership. As mentioned before, stocks represent a fractional share or equity of a listed company.
However, ownership depends on whether you are trading the real market or a derivative of it. You can trade shares as derivatives where you don’t own the actual stocks from an exchange.
On the other hand, options are already derivatives, meaning there is no equity involved in the traded asset.
Stocks have historically always had lower margin compared to other assets like crypto and forex. You’ll be hard-pressed to find a broker providing 50:1 leverage in this department. On the other hand, there is more leeway with options, especially with the exotic types.
The higher leverage means that you need less capital, while more money is necessary when investing in stocks. Also, it allows you the potential to make the most profit (but you can also lose a lot of money quickly).
Another significant contrast when observing stock trading vs options trading is the time horizon. With stocks, you can hold a position for an indefinite period, provided you have enough money. Conversely, options have a time limit.
One brilliant advantage of options over most financial assets is that you always have a known loss amount thanks to the premium. You know that, even if your prediction is wrong, you won’t lose above a certain amount.
Other markets like stocks and forex rely on stop losses, which aren’t technically fixed. It’s common for traders to remove a stop or not use one at all. This means they can lose a lot more than intended.
Options or stocks, which should you choose?
We’ve now come to the end of our stock trading vs options trading head-to-head. You will probably be asking yourself what should one choose between stocks and options.
Both markets have immense profit potential once you’ve mastered them. Stocks have a greater legacy and are regarded as the old-fashioned way of investing. Although options are quite old too, they are more suitable for short-term trading.
The main contributor is, of course, the leverage, which appeals to day traders and scalpers. So, it’s harder to scalp or day-trade with equities due to the lower leverage.
However, nothing is stopping you from participating in both markets. In fact, this is quite common. Many investors may have stocks as their primary asset, and use options as a secondary option for hedging.
Here, you can take one position in stocks and the opposite direction on a stock option. The point is that the two can co-exist with each other. Alternatively, you can decide to focus on one. Regardless, both securities are equally challenging to master and require years of dedication before you bear fruits.