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Lesson 3: Options vs Stocks

Options vs Stocks, Options, Stocks, Options for beginners

Options vs Stocks, Options, Stocks, Options for beginnersIn the first article of this Options Course, we have seen what an option is, and the first elements characterising it. Let's completing, now, the part regarding the break-even point and then we will compare the Options vs Stocks.

The break-even point is the point at which total cost and total revenue are equal; there is no net loss or gain. In a CALL option, the break-even point is obtained by adding the premium paid and the commissions to the strike. In a PUT option, instead, the break-even point is obtained by subtracting the premium paid and the commissions from the strike.

When we buy shares, we risk the whole value we are investing. By buying an option, we will have a limited risk and defined by the premium paid. In the example of Apple (previous article), the $ 176.00 paid buying the call option represents our highest risk, unlike a stock which can be subjected to a severe breakdown and cause to us substantial losses.

The profits are, instead, potentially unlimited, like for the stock the price, in theory, can go up infinitely. Margins required by the broker are however much lower for an option than for 100 Apple shares.

However, while with the shares we get dividends, given that the markets issue the options and not the companies, they do not have dividends.

Now a question: why is it that the bought options turn out to be so affordable? Why does the option premium cost so little compared with the purchase of the shares? The answer is simple: because the probability is not in our favour. In fact, to earn when buying options do not just we have to predict where the market could go, but also within how long.

Summarised in the bottom line below the pros and cons of the two financial instruments, shares and options:

 

Stocks

Pros:   Dividends.

            They are not subject to expires.

Cons:  Potentially unlimited risk.

            They are expensive.

 

Options

Pros:    They are cheap.

             Very high risk/reward ratio.

Cons:   They are subject to expiration.

             Lower profit probabilities.

 

So options vs stocks, which is better? Both instruments are valid; it depends on where we want to use them and with what goals. Options attract many people because of their account size. They assume they can trade larger or using leverage for making more money, and this is a wrong way to trade.

 

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