Options vs. Stocks: Which One Is Better for You?

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Stocks and options are two types of securities investors trade on the open market. While they do have similarities, they also differ in important ways that you should understand before you invest in either.

Options vs. Stocks: Which Is Right for Your Investment Portfolio?

This options vs. stocks comparison will help you determine which investment type will best help you reach your financial goals.

Stocks

A stock is a fractional share of ownership in a company. Investors buy stock with the hope that the share price will rise, making the stock more valuable than when the investors purchased it. In addition to the possibility of appreciation, stocks give shareholders voting rights that help shape the company’s direction. Some also pay dividends, which are a company’s way of returning a portion of its profits to shareholders.

Most stocks are traded on stock exchanges and have indefinite lifespans. As long as the business continues to operate and trade publicly, the stocks will continue to exist.

Stock prices are in constant flux due to a variety of factors, from the company’s financial performance to news about events that affect the economy. However, the overall performance of a stock usually tracks a company’s growth. Whereas ever-increasing stock prices are often a good sign for investors, falling prices can cost investors some or all of their investment.

Benefits of Stocks

Investing in stocks comes with several benefits:

• Stocks last indefinitely since their lifespan is associated with the duration of the company’s operation.
• Some stocks pay dividends. Dividends provide income to the shareholder even if the stock price is down.
• Many brokers offer free trading.
• Publicly traded stocks tend to be highly liquid. You can sell your stocks for cash whenever the market is open.
• Investors get a break on capital gains tax when they hold stock for more than a year.
• Investors can buy stocks individually or invest in baskets of stocks by purchasing shares in a mutual or exchange-traded funds. The funds are an easy and cost-effective way to diversify a portfolio.

Shortcomings of Stocks

Although stocks are an important part of many investors’ investing strategy, they have some disadvantages:

• A stock’s price can fluctuate heavily, going to either extreme. Thus, you may not be able to sell a stock for the price you paid for it.
• Funds that invest in stocks are not insured or guaranteed. If the stock price drops or the company goes under, you could lose some or all of your investment.
• Stock prices rise and fall based on a company’s performance, so choosing the right stock requires a lot of research.
• Analyzing stocks can be arduous since you have to consider different metrics and may even have to read multiple performance reports to determine if a stock is worth investing in.

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Options

Options give you the right to sell or purchase a stock or other asset at a specific price, called a strike price, by a specific date. They’re called “derivatives” because they derive their value by the underlying securities from which the investor hopes to profit. Investors use options to gain a strategic advantage but are not obligated to buy or sell. If not executed by the expiration date, however, the option becomes worthless.

The two types of options are:

• Put options: Put options allow investors to sell a particular stock by a certain date at a specific price.
  • Generally, investors who buy put options expect the actual price of the stock on the market to be lower than their options price so that they maintain the right to sell at above market value.
• Call options: A call option lets you buy the stock by a certain date at a specific price. Investors who buy call options usually expect the price of the stock to increase so that they can buy it below market value.

Many online brokers offer commission-free options trading, but you’ll typically pay a small fee per contract. Schwab, for example, charges $0.65 per contract.

Benefits of Options

Here are some advantages of owning options:

• Options are leveraged investments. You can generate gains for a much smaller amount of capital than it would take to buy a stock, as each options contract gives you control over 100 shares. For example, if you want to buy 100 shares of Apple you might have to lay out $20,000 or more, but buying a single call option, which gives you the right to buy 100 Apple shares, may only cost you a few hundred dollars.
• Commission-free online brokers make trading relatively inexpensive.
• If you hold options for a long time, you may qualify for long-term capital gains tax rates, which are generally lower. But longer contracts may have higher risk.

Shortcomings of Options

Since options can be even more volatile than stocks, there are a few disadvantages that you should know beforehand:

• The price of an option’s underlying asset can fluctuate massively. There is a high risk of potential loss, perhaps as much as your entire investment.
• The government does not insure or guarantee options, which means you may lose your money.
• Since options are time-restricted, you cannot trade them after the expiration date. If your options expire without having been used or sold, they become worthless.
• Because trading options is an advanced and potentially risky strategy, you’ll have to submit an application to your broker for approval to trade them.

Stocks vs. Options Comparison

The comparison table below summarizes the features of both investment types:

What You Should Know About Stock Investing

Stocks represent a share of ownership in a company. When you buy a share of stock, you actually own part of that company, albeit a very tiny percentage. Apple, for example, has over 15.4 billion shares outstanding, meaning if you pick up 100, you own essentially 0% of the company. But if you’re a big investor like Warren Buffett, for example, you can own a significant amount of a company. Buffett’s Berkshire Hathaway owns over 789 million Apple shares, meaning it owns 5.1% of the company.

You don’t have to be a big investor to participate in the upside of a company. Whether you own 1 share or 100 million, you still earn the same percentage return when a stock moves up in value — or lose the same percentage if the stock falls. Similarly, the dividend yield of a stock is the same for all investors, regardless of share count. While you’ll receive more actual cash if you own more shares, the yield percentage remains the same.

If a stock pays a dividend of $1 per share and its share price is $50, that represents a yield of 2%. If you own 1 share, you’ll earn $1 in income on your $50 investment. But if you own 100 million shares, while you will earn $100 million in cash, you’ll have to buy $5 billion to earn it. Either way, you will be earning a 2% yield on your investment.

What You Should Know About Options

Options, on the other hand, are derivative investments. This means they only “derive” their value from the value of a different investment. Specifically, an option only has value in relation to the security that it is linked to, which is often a stock.

Unlike stocks, options don’t convey an ownership interest in anything. Rather, they are contracts that give you the right to buy or sell a stock or other security at the price specified in the contract within a specified period of time. For example, if you buy an October 250 call option on Apple, it gives you the right to buy 100 shares of Apple at $250 per share anytime before its October expiration date. For this right, you might have to pay $200. If you don’t exercise your option before it expires, it will become worthless.

There are many different types of options and options strategies, from the conservative to the highly aggressive, and it can take some time to learn how to invest in them properly. But the important thing to know is that an option does not give you ownership in a company unless you exercise it and purchase shares of actual stock.

Investing in either stocks or options gives you a chance to earn lucrative gains on your investment, but that opportunity comes at the risk of losing money. The risk is significantly higher with options — but so are the potential rewards.

Stocks vs. Options: Which Is Better?

One is not inherently better than the other. When choosing between options and stocks, the best choice is the one the fits your investing goals, your experience as an investor and your tolerance for risk.

Stocks for the Experienced

If you are fairly experienced with the stock market and prefer long-term investments, stocks are the way to go.

Options for Strategic Approaches to Investing

Meanwhile, options are better for investors with a strategic investment approach and a high tolerance for risk. If you want to multiply your investment in a short span and are willing to do the legwork, you might consider options.

Since it requires additional research, investing in options is better for advanced investors who know how to minimize risk and strategically benefit from market trends.

Final Take

While stocks are indefinitely yours and follow the trajectory of the company’s performance, options are time-bound. They can earn a high return on investment in a limited period — but can also lead to greater losses.

Both investment types come with substantial risks and gains. Never invest more money than you an afford to lose.

John Csiszar and Daria Uhlig contributed to the reporting for this article.

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