Options or Stocks? Where should you put your capital and which one is better for you? Is options trading better than stocks? Stock trading vs Options trading help in finding the differences and in choosing the right format of trading for you.
So, let’s get started.
What is Stock Trading?
To understand the differences between the two formats of trading it is important to first understand their respective meanings.
Stock trading is all about buying and selling shares of the company. Here the investor expects profit from the change in stock prices which generally depends upon the business growth. It can be done for a day (intraday) or one can hold shares of the company for a few weeks to months (swing trading).
Since we are comparing stock trading with options, which is a short form of trading, hence it makes more sense to compare swing trading with options trading. The following listed parameters are defined in terms of swing trading.
- Capital Requirement
Stock trading is where the trader takes the delivery of shares and holds it for a few weeks to months to earn profit. Here the initial capital requirement depends upon the stock chosen and the position sizing. For example, if you want to buy 100 shares of ABC company which is currently trading at ₹1000 then you would need ₹1,00,000/- capital to execute this trade.
Thus, you can choose the amount you would like to invest in the market.
- Risk and Reward
Stock trading is less risky as it does not come with any expiry. You can exit the trade whenever the stock moves to its highest value in that particular time frame. Also, you can minimize your loss by averaging your position or by using a trailing stop loss.
- Leverage
No leverage is provided for delivery trading in stocks. Hence the trader has to use all the capital by himself to take a position in the market. However, if you opt for intraday trading then you can avail up to 5 times margin from your stock broker.
- Liquidity
Liquidity is something that helps you in determining the demand and supply of a particular share. Now, when it comes to demand and supply, it cannot be the same every day and moreover, it depends upon the stock of the company you hold.
It is therefore important to choose liquid stocks and take or exit the position when market conditions are favorable.
- Complexity
To trade in stocks one needs to understand the technicals of the market. For this, one must gain a complete understanding of charts, different types of technical indicators, chart patterns, etc. Also, timing the market is important to earn profit, and therefore for a short-term trade, one needs to pick the right swing trading time frames.
After understanding one can build his or her own strategy and stick to it to make profitable trades in the stock market.
What is Options Trading?
Now, let’s understand options trading. Options trading is buying and selling a contract where buyers pay a premium to the seller and gain the right but not the obligation to settle the trade at the pre-determined price in the future.
Bit complex to understand how to do option trading. Right?
Let’s continue with the above example, where you want to buy shares of ABC company trading at ₹1000. Now to execute stock trading you need a capital of ₹1,00,000, and will only earn profit from your position when the stock price actually rises in the future.
However, with options trading, you can gain the right to buy this share at ₹1000 at the predetermined date (here 1 month) in the future when the stock price rises. To take a position in the market you just need to pay the premium amount. So, let’s say the LTP in share market to buy the option contract is ₹100.
Unlike stock trading where one can choose the number of shares to buy and sell, option trading can only be done in lots. Suppose the lot size is 100 shares. Now, to take a position in the market you just need to pay ₹10,000 unlike ₹1,00,000 in stock trading.
Now after 1 month on the expiry day (pre-determined date) the stock price closed at ₹1,250. Since you were holding an option contract to buy shares at ₹1000, hence the trade would be settled in your favor where you can buy these shares at ₹1000 and sell them at CMP, i.e. ₹1,200 in the market.
On the other side of this, if the stock price goes down to ₹800, then in stock trading you would have to exit the trade at the loss of ₹200 per share. However, in options trading where the buyer has the right not to execute the trade, you would lose the entire premium amount i.e. ₹10,000.
Let’s understand the capital requirement, risk, and reward of trading options in more detail.
- Capital Requirement
When it comes to trade, many people want to start small and gain a high return. In this situation, many beginner traders look forward to start option trading with 1000 rupees.
Now, is it possible?
Well, it is but at the same time in options trading, the capital requirement for both buyers and sellers varies. Buyers open positions for options trading only by premium, however, sellers need to maintain a minimum option trading margin in the trading account. The capital requirement further depends upon the trend, current volatility, and time to expiry of the option.
Also, one has to buy or sell a minimum of 1 lot (with x number of shares) hence the minimum capital depends upon the lot size of the option you buy or sell.
- Risk and Reward
In comparison to stock trading, options provide better returns to buyers, however, if the market goes south then the buyer loses all the premium amount paid to the seller.
On the other hand, the profit of the seller is limited to a premium amount and the loss is unlimited as the seller are obligated to settle the trade at the predetermined price on expiry.
- Leverage
The option buyers can take a position to buy shares at the pre-determined value in the future, hence the initial capital requirement is low. Thus, one can reap the benefit of high leverage in options trading.
- Liquidity
When it comes to liquidity, options are comparatively less liquid than stocks. Furthermore, comparing index options and stock options, again stock options are less liquid and thus are riskier. Also, buying a deep OTM option can lead to losses due to less liquidity.
- Complexity
No doubt, options trading is complex in nature, and one needs to understand different parameters. Here it is important to know what does option chain indicate and how to use its data for proper and right analysis of data.
In short, one needs to know the technical aspects of the market and understand different strategies to increase the chances to earn profit in the market.
Here swing trading in stocks and options trading in stocks are done with the intention to earn profit within a month but which one could be more profitable, for this swing trading vs options can help you better.
Is Option Trading Better than Stocks?
Let’s quickly now compare the different aspects of stock trading vs options trading discussed above. In the table below understand the major differences between the two trading formats and choose the right one to earn good profit in the market.
| Stock Trading vs Options Trading | ||
| Trait | Stocks | Options |
| Type of Asset | Actual ownership in the company | Derivative of an underlying asset |
| Risk/Reward | Limited potential reward, limited potential risk | Mostly Limited risk, unlimited potential reward |
| Timeframe | No expiration date (depends on trading type) | Expiration date is usually within a week to three months |
| Profitability | Profit is made when the stock price increases and the shares are sold for a higher price | Profit is made by buying the option at a low price and selling it at a higher price, or by exercising the option and buying or selling the underlying asset at a profit |
| Leverage | No leverage | High leverage |
| Cost | Purchase price of the stock | Premium paid for the option |
| Strategy | Either buy and hold, or buy low and sell high | Speculation, hedging, or even income generation |
| Liquidity | Can be highly liquid, depending on the company and market conditions | Can be less liquid than equities, depending on the strike price and expiration date |
| Complexity | Relatively simple | Can be complex, with different strike prices and expiration dates |
Also, all the profit earned in options trade is considered as your business income and is calculated using option turnover value.
Conclusion
There is a saying that “Practice makes a man perfect.” It is applicable in the stock market as well. The more you learn and trade a single type, the more confident you can become in it. Stock Trading vs Options Trading highlighted some of the major aspects that need to be considered by a beginner to choose the trading product and segment wisely.
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