How Buying Options More Profitable Than Buying The Stock Itself?
Before into details, you must have an idea of what are options and stocks?
Stock is the ownership share in a company. When you buy stock shares, it means you have purchased part of the company that issued the stock. Why people invest in stocks? It is simple, they want to buy stock, and they sell those stocks when prices are higher.
In this way, they can make quick money. Options trading is a different thing.
When you invest in stock options, it means you are purchasing the right to buy and sell options at a specific price within the specified time frame (for American style stock option).
In this article, you will find out how is buying options more profitable than buying the stock itself?
Advantages of Buying Options over Buying the Stock Itself
Stocks have been around for more than 40 years, but options are now starting to get the importance and value they deserve.
Still, many investors don’t invest in options because they feel options are difficult to understand. Many investors have lost their money in options because neither they nor their brokers had the proper training of options trading.
No doubt, you can make massive profits by options trading, but if it isn’t used correctly, it can lead to serious problems. So, for an investor, it is important to know both sides of the story before making any decision.
Key Advantages of Buying Options
Trading options is much better than stock trading if you can understand how to deal with them.
If you want to buy an option position similar to the stock position, you can buy at much less price than the stock position. However, it is not quite as simple as it looks. In options trading, investors have to pick the right call to purchase the right stock position. Experts will say it is silly because of time decay and option prices are usually higher due to volatility. Nevertheless, this stock-replacement strategy is cost-effective and viable for big-cap stocks.
In options trading, you can start at $100, although it is not recommended. If you can use this amount wisely and don’t waste all your money in one trade, you can make a huge profit.
Most of the time, buying options can be riskier than owning equities. However, you can use options to limit the exact risk.
What makes options safer? It’s the total dependable form of hedge that makes them safe. When investors invest in stocks, for position protection, a stop-loss order is used. This order is used to stop losses beyond the price set by the investor. But there is a big problem with the order itself. A stop order only works when the trade is at or below the limit indicated in the order.
For options investors, you can set a spread with 2 options (e.g. buy 1 put and sell 1 put at a different strike price, can be either bear-ish or bull-ish). You can then decide upfront the risk/max loss. In some cases, you can be directionless too but at a higher cost for the risk usually.
Warning: This works both ways. When you invest a little and get the same amount of stock movement, options can offer a high return percentage. Investors enjoy this high rate of return.
However, if you are investing too much and trade doesn’t go your way, you will have to bear a massive loss. Nevertheless, you can your limit risk again.
Another significant advantage of options is, you have more investment alternatives. Options are very flexible, and you can use them to create other positions. These positions are called synthetic. These positions allow investors to achieve financial goals. You will enjoy lots of other strategic alternatives while using options.
Why Should You Invest In Options or Stocks?
Options trading offer lots of advantages over stock investing. So have a look at some more benefits of options trading.
- Options don’t tie your investment as much as the regular stocks do. So, you can use this money on other projects. As an investor, you want to invest in projects which require a minimum investment.
- Options offer you the flexibility to decide when you use your put or call option. Because buyers and sellers are both deciding the strike price, so it gives you the predictability. It gives you an estimate of how much profit or loss will be by exercising an option.
Cons of Options Trading
When options trading offers lots of excellent benefits, at the same time, it has some potential drawbacks as well. The potential of loss in options trading is more than the stock trading. In options trading, you make a bet that either the price will go in this way or another. If your assumptions about stock price movements turn out to be wrong, then it will result in a loss instead of profits. In options trading, time plays a crucial role, so incorrect timing of exercising an option can result in a massive loss.
You can’t say that investing in stocks is risk-free activity. When you have invested in stocks, there may be a time when the market goes through periods of volatility. But in stocks trading, the advantage you enjoy over options is, you don’t have pressure to sell. In stock trading, you can buy a stock at one price and sell it immediately. In this way, you can earn small profits. You can buy shares and hold them for years and sell them when you feel it is the right time.
Once you are familiar with the primary advantages of options, you would prefer options over buying stocks. Options provide you the leverage, and online brokers offer you access to the biggest markets.
It is the flexibility of the options tool that makes it more attractive than stocks. If you can spare some time to learn options trading, it can be a game-changer for you. It is the start of a new era for investors. So, if you are planning to invest in the stock market, look for options trading instead of stocks trading. Understand the strategy to minimize risks, and you can make more profit with minimum investment. So, buying options is more profitable than buying the stock itself.
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.