Options vs. Stocks: Which Is Best for You? (2024)

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

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

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

Stocks represent a share of ownership in a company. Options, on the other hand, are contracts that give you the right to buy or sell stock or other security at the price specified in the contract.

Investing in either 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.

What Are 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 you 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.
• While holding a stock for over a year has some tax benefits over short-term investing, the effective tax rate never hits zero. You will always have some tax liability when you sell stock at a profit.

What Are 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:

• Whereas you can buy one stock, options usually come in bundles of one hundred. By owning the right options, you can multiply your money much more substantially over a short period because of the number of underlying securities.
• 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 losing your 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.
• Since options are bundled, they require a more sizeable investment than most stocks.
• Because options are so complicated and risky, you’ll have to submit an application to your broker for approval to trade them.

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 have significant stock market experience 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.

Stocks vs. Options Comparison

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

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.

Daria Uhlig contributed to the reporting for this article.