Is trading options better than stocks? A lot of people believe it to be so because trading stocks poses far more risks than what trading options has. However, if you’re interested in finding out for yourself whether trading options is better than trading stocks, it would definitely help you out if you understood first the differences in trading options and stocks.
Options and stocks defined
Options are what you would call as derivative instruments that are based on stocks and others like commodities, funds, futures, and index. Derivative instruments are what you call trading instruments whose values depend on another security. Simply this means that the price of an option moves up and down as guided by fluctuations in the price of underlying securities. Stock options derive their value from underlying stock, letting investors buy or sell stocks at certain prices. Stock options then are not the stocks themselves. Rather, they are the contracts that give you power to buy or sell underlying stock. Stocks are what give you ownership in a company. How much control you have over a company will depend on how much of its stocks you own. The only thing similar between options and stocks is that you can both buy and sell them. Otherwise, the two behave very differently from each other.
Advantages of trading options
Consider the following reasons why trading options is better than trading stocks:
- Variable leverage. Trading options gives you leverage that allows you to do more while using the same amount of money. This in turn opens up opportunities for you to make a whole lot more profit compared to trading stocks when the same underlying stock moves. For example, when you buy a stock without margin, you can make a meager 1% profit when 1% of the stock’s price moves in your favor. When you trade options though, you’re looking at the possibility of making 10% in profits or even as high as 100% on the same 1% move. Please remember that as the profit possibility is leveraged also the risk of losing is leveraged in options trading.
- Low capital requirement. Since you’re not actually trading with the underlying stock, you don’t have to put out capital that matches the cost of the stock, making trading options more accessible to more investors and traders, most especially those just starting out and are interested in testing the waters first.
- Controls losses. Because of the leverage you get with trading options, you can do the same kinds of trades using less money, giving you the chance to simply use money you intend to and know you can lose should a trade fail. Since you’re only working with money you can lose, you have better control over your losses since you will be dealing with fewer complications. Losses are part of trading and for the most part you can’t avoid them, but at least trading options will afford you better control over them.
- Allows betting downwards without margin. Typically, profiting from a downwards move on stocks involves shorting stocks with margins. In trading options, you simply have to buy put options without margins. If you want to make the most out of an upwards move, just buy call options.
- Profits from all sides. When you trade stocks, you only make profits when stocks go the way you want them to: upwards when you’re buying and downwards when you’re shorting. You simply cannot make profits both ways and you most definitely can’t make money out of stocks that don’t move. Trading options makes all of these possible though, with various strategies allowing you to make money no matter what way the stocks go. Since you can make money whatever you decide to do, you must realize that there is also a chance to lose out when you engage in trading options.