When you want to invest in the stock market, you have two options - you can either buy stocks which gives you a share in the individual company, or you can buy options which let you make money on your view of the stock’s future direction. There are important differences between stocks and options. Understanding the difference can help you choose one or both based on your needs and personal investing style.

What is Options Trading?

Options are contracts to buy or sell stocks (or another asset) at a given price (strike price) up to a specific date (maturity/expiration date). As opposed to the stock trading, where an investor owns a part of the company, options contracts do not allow for direct ownership of the company.

Types of Options and related risks

Options have two variants - call option and put option. Both follow a similar pattern as far as gain/loss is concerned.

A call option gives the buyer the right to buy the asset (like company shares) at a pre-set price.

A put option entitles the buyer to sell the asset at a pre-determined price.

Options are bought by paying a premium, which is market-determined after considering factors like the underlying asset (stock or commodity), the option time period and volatility in the asset’s price.

The NSE option chain gives a complete listing of put option and call option strike prices, along with their premium for a given maturity period. This gives investors a clear view on current trends and if they are likely to make money on their options.

Advantages and Disadvantages of Options Trading

Options are a double-edged sword that can hurt or benefit the investor.

Options trading can add value to the investor’s finances in several ways:

• Options contract brings leverage to the table - this way you can control more stock for the same amount of money.

• With options contract, you are well-placed to ride price movements at controlled risk.

• The buyer of the option has limited risk capped by the premium amount.

• Options boost your future positions in the stock market.

Options trading have their fair share of disadvantages:

• Investing in option contracts calls for active portfolio management which places greater demand on one’s time and calls for a more active approach compared to stock trading.

• The opportunity window in options is limited; chances of making money diminish as it nears maturity.

• Investors need a margin account before they can trade with options.

• Liquidity can be quite low with specific options.

• Certain options strategies like daily or weekly options are riskier, making it unviable for inexperienced traders.

• Cost associated with options trading is higher than with stocks.

What is Stock Trading?

By trading in the stock markets, investors buy shares in the company giving them actual ownership of the company in proportion to their share investments.

This is unlike options, where there is a contract to buy/sell shares in the company, and not actual purchase/sale of shares.

Stock trading also has its share of advantages and disadvantages.

Advantages:

• More suitable for investors with a straightforward investment approach, which means they have a far broader appeal than options.

• For investors with long-term goals like child’s education, retirement, stocks have higher utility than other assets.

• Fees on stock investing are generally lower than on options.

• If you do not have time and resources to actively track markets for opportunities, then buying a few stocks and staying with them for the long-term is a good strategy.

While stock trading has disadvantages, these are not in relation to option trading. Meaning stocks can be volatile which can be worrisome for an investor, but that is the nature of the beast. Investing in stocks entails brokerage and related fees, which is also the case with options. Investors can burn their fingers with stocks that do not perform as expected, which is equally true for option trading.

Whether you choose to go with stocks or options depends much on your preferences, finances and investing style. Investors who are just starting out and like to keep it simple may prefer stock trading. Seasoned investors, who prefer a more active investment approach with regards to market movements, may choose options trading.

No one investment is better or preferable by itself or should be ruled out for investing in the other option. Options traders can also become stock investors on exercising the call option. Likewise, seasoned stock traders use put options as a hedge. Either or both can work for the investor, only thing is he must know what he is getting into in terms of related risks and rewards. 

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