Most people think of trading options as a substitute for trading stocks in the stock market. Stock options represent massive leverage and allow small time investors like you and me to reap huge profits from stocks that we would not normally be able to buy. With stock options it is possible to get gains of 400% (even more) on an underlying stock that had a price movement of only 5 or 10%. Here are some other key differences between stocks and options.
All Stock Options Expire at some point
All stock options have expiration dates while stocks represent ownership in a company and never actually expire. Fortunately, you can pick how much time you have before your option expires. You can buy or sell options that have a few months to expiration or you can purchase LEAPS which won’t expire for at least a year.
Note: some of the options that companies give to their employees don’t expire for several years. You can’t buy these on the stock market.
You can set up options positions that will let you profit no matter what happens
With stock positions you can only make money if the stock moves in one direction. If you buy a stock you will only make money if the stock goes up in price. If you sell a stock (known as short selling) you will only make money if the stock goes down in price.
There are some stock options positions you can set up which will allow you to profit whether the stock price goes up, stays flat, or goes down.
Owning a stock option does no give any rights or shares of the underlying company.
A stock represents a piece of ownership of the company. So if you bought 1,000 shares of stock on company xyz you are actually purchasing shares of ownership of the company.
With stock options you are purchasing or selling the right to ownership of a stock. You may own a stock option but this is a lot different than actually owning a piece of a company.
With Options you can get your profits upfront
With stock trades you have to wait for price movement in order to receive some profits. With stock options you can set up credit trades that allow you to lock in your profits the minute you make the trade.
For example with covered call writing and naked put selling you will receive a premium upfront for selling these contracts to a buyer. This is actually a great way to get paid to buy and sell stocks and is a strategy that I use personally.