When it comes to investing, there are a few different options that people can choose from. One of the most popular is trading stocks, where an investor buys shares in a company with the hope that the stock will go up in value and they can sell those shares for a profit.
Another option is stock options, which are contracts between two parties that give the buyer the right (but not obligation) to buy or sell a set number of shares at a predetermined price within a certain time frame.
Both of these options present unique opportunities for investors. You can enjoy a very profitable trading strategy with either of these. But which is better?
To answer that, we need to address the differences between stock options and stock. After we do that, we’ll be better equipped to help you choose the right investment strategy. Let’s take a closer look at the differences between stock options vs stock:
Stock Options vs Stock: Breaking Down The Differences
While the untrained eye will see “stock vs stock options” and think we are talking about very similar commodities, there are actually striking differences between these two. To uncover these key differences, we want to begin by defining each of these asset types:
What Are Stock Options?
First things first – what are stock options? And, how do they work?
A stock option is a contract that allows the holder to buy or sell shares of an underlying stock at a set price on or before a certain date.
The key word here is “contract.” Unlike stocks, which are actual equity ownership in a company, options are just contracts. They derive their value from an underlying asset, which in this case would be stocks. However, there are options contracts for everything out there – from gold to cattle.
Further complicating matters there are two types of options contracts: puts and calls. Remember earlier when we said that these contracts give you either the right to buy or sell stock? Well, this key difference will be dictated by the type of contract you purchase. Here is a quick explanation:
- Call options: gives the holder of the contract the right – not the obligation – to buy company stock.
- Put options: gives the holder of the contract the right – not the obligation – to sell company stock.
When trading stock options, your goal is to identify favorable contract terms. You’re making an educated guess about what you expect to happen with a stock’s price – no different than traditional stock market trading. Let’s break it down for you with an example.
Say you buy a call options contract for company XYZ. The contract terms are as follows:
- Quantity: 100 shares
- Strike price: $10/share
- Exercise date: 1 year from today
In this case, you are banking on company XYZ’s price rising before the exercise date. If it rises to $15 a share in 6-8 months, you can exercise your options – buying 100 shares at a discount compared to market value. You can then turn around and sell your shares for a profit.
What Are Stocks?
On the other hand, stocks represent ownership in a company. When you buy shares of company XYZ, you now own part of that company and have voting rights (if it’s a public company). This is one of the major differences between stock options vs stocks. Options contracts are sold among investors – and represent no ownership until you cash in and buy the shares (in the example listed above).
You also have the potential to earn dividends if the company pays them out and you can reap the rewards if/when the company is sold or goes public.
Stocks are a much simpler, easier-to-understand asset – which is why beginners are better suited to trading stocks rather than options. With this said, let’s take a look at all the pros and cons of both options and stocks.
Trading Stock Options vs Stock: Which Is Right For You?
Whether you ultimately decide to trade stock options or stocks, the principles will be the same. You will conduct market research/technical research to find good opportunities. Both stock options and stock trading may have a place in your investment strategy – more on that later. For now, we want to help you choose just one – so you can dedicate yourself entirely to learning how to trade that asset.
Now that we have a better understanding of these key differences and similarities, we can begin to answer the question: which is better – stock options or stocks?
It really depends on your investment goals and what you’re looking for in an investment. If you’re looking for long-term growth potential, then stocks might be the right choice. If you’re more interested in short-term speculation, then stock options might be a better fit. But to really help you make the right choice, let’s look at the pros and cons of each.
Pros and Cons of Stock Options
- Can offer high returns if you make the right predictions
- Leverage – options contracts allow you to control a large number of shares with a relatively small amount of money
- Options can be used to hedge against losses in other investments
- Can be complex and confusing for beginners
- The underlying asset must move in the predicted direction, and by a large enough margin, for the trade to be profitable
- Your profit is capped at the contract’s strike price
Pros and Cons of Stocks
- One of the simplest investments out there – easy to understand and trade
- No limit to how much money you can make – your profits are not capped like they are with options contracts
- You own a piece of the company and have voting rights (if it’s a public company)
- Can receive dividends if the company pays them out
- Relatively low returns compared to other investments – stock prices tend to rise slowly over time
- Your investment can lose value if the stock price falls
Stocks vs Stock Options: The Final Verdict
So, which of these should you choose? We’ve broken down the key differences between stocks and stock options along with the pros and cons of each. As you now know, stock options are a bit more complicated – but offer great profit potential, leverage, and risk management. Stocks, on the other hand, are far more simple and grant you ownership over the company in question. You’ll earn dividends, too. However, the overall return may be smaller than an options contract.
The best way to determine which is right for you? Try trading both and determine which style you like more. Ultimately you don’t have to choose one over the other. Similar to the debate of swing trading vs investing long term or swing trading vs position trading, you can incorporate both into your investment strategy.
If you’re a beginner, stick with stocks. If you’re more experienced, try dabbling in options contracts. We offer an awesome options trading course to help you hit the ground running at a high rate of success – take a look and see if it is the right approach for you.
Parting Thoughts On Stock vs Stock Options
We hope this quick article has helped you gain a better understanding of whether you should trade company stock or stock options contracts. You now know the key differences between these assets and the unique pros and cons of each. Only you can determine which of these is right for you. If you are a more active trader and want to hedge risk while earning substantial profits, options contracts are a great choice. If you want to keep things simple and enjoy unlimited profit potential, trading stocks might be your best bet.
No matter which approach to investing you take, we encourage you to set yourself up for success by taking the time to learn. We have a really helpful resource on swing trading options and a great guide to swing trading for beginners. Along with arming yourself with knowledge, you need to equip yourself with the right tools. And one tool no trader should ever do without is a quality stock forecasting software.
At VectorVest, you can gain access to the information you need to start trading in confidence. You’ll be able to find winning opportunities on autopilot with our prebuilt searches that pull up the hottest stocks at any given time. And, you’ll know exactly when to get in and out of your position as we help you time the market with ease. With a clear buy, sell, or hold recommendation for any stock, any time, you’ll never have to play the guessing game again. See the difference for yourself with a risk-free trial today.