5 differences between options trading and stock trading
A trader’s or investor’s intention at any given time is to make profits with a minimum level of risk. Options trading and trading stocks are very distinct in their characteristics. It is of the utmost importance for a trader to understand both concepts and terminologies before engaging in trade.
What is Options Trading?
An option is defined as a contract that allows you, but does not necessarily obligate you, to purchase or sell an underlying asset. These underlying assets or instruments include ETF, index or security at a previously pre-agreed price, and over an agreed time frame.
Options trading happens in an options market, which deals with contracts based on security. Purchasing options that allow you to buy shares later is a “call option,” and buying an option that lets you sell shares later is a “put option.”
What Is Stock Trading?
Stock trading is defined as the selling and buying of stocks or shares. These stocks represent part ownership of businesses and may include privately sold stock or securities that have been listed on a public stock exchange.
5 Differences between Options and Stock Trading
Here are five differences between these two types of trading:
Options Trading Is Cheaper
In comparison to stocks, options trading is not as expensive as the securities they are based on. For each option contract, you gain control of one hundred equity shares. The cost of buying an option contract is not even close to the cost of purchasing an equivalent percentage of stocks. Once you buy an options contract, you pay a premium to enter into options trading. This premium is pegged on several items, including the underlying equity price.
Options Utilizes Leverage to Increase Profits
Options are cheaper to buy in comparison to purchasing an equal number of shares, providing you with leverage. Leverage allows you to get more profits that are not in proportion with only the initial investment you put in.
Time Frame
Options trading methods are usually short term, ranging from several weeks to months. This is style is more suited for seasoned investors, making them more suited for investors who are regular buyers and sellers. Stock trading is more suited for beginners, and it is more of a long- term investment. If you are looking to invest for goals over five or even ten years, for instance, for retirement, stocks trading is the way to go. There may not be a guarantee of making money in stocks, as they can be extremely volatile, but it is much safer in the long term.
Option Trading is Riskier
Options trading needs a more experienced trader who can trade with a hands-on approach. Since all options trading contracts have expiry dates, you will need to keep an eye on the stocks’ prices. You can plan on setting alerts via your online broker. If you want to make a success out of options trading as a beginner, do not settle for daily and weekly options, as they are more suited for experienced traders.
Options Trading is Flexible
If you are interested in an investment method, that has a smaller requirement in terms of investment and flexibility, options trading may be what you need. In options trading, the periods are shorter, which makes it more attractive to traders who buy and sell regularly. Options attract the most people because you can wait and see how a stock behaves. You can lock in prices without having to buy by making three decisions:
- Deciding the direction the stock is heading
- Deciding how far up or down the stock will move from the current price
- The expected time frame this might happen
As an investor, you can let an option contract expire without incurring any costs except the premium paid and any related trading costs. Buying put options helps to prevent any losses in the future if your stock value plummets. The price paid for the option or premium acts as an insurance premium.
Conclusion
Before engaging in any trading, bit it options or stock, find out the pros and cons of each. Most people fail in trading because of not doing enough research and being impatient. Learn all the terms of trade and engage a reputable stockbroker to guide you.