If you’re looking to get into investing, chances are that you’ve come across the terms “stocks” and “options”. While both have their pros and cons, and can even complement one another in a portfolio, financial terms like options vs. stocks can be difficult to understand.

The main difference between the two is that stocks represent ownership in a particular company, while options are contracts with other investors that let you bet on which direction you think a stock may be moving. Before we launch into a more detailed discussion of options vs. stocks, let’s first start with the beginner basics.

Stocks: The Basics

Chances are, most people are familiar with stocks, or at least know that public companies like Apple or Microsoft have stocks that people can invest in. There is no guarantee that you’ll make money in the stock market, as the performance of any individual stock from one day to the next can be quite volatile, but the US stock market is largely considered to be a strong long-term investment.

Investing in stocks is simple: you buy a stock, hoping its price will rise so you can sell it and make a profit. Many seasoned investors have their own opinions about whether or not it’s best to hold onto a stock for a long period of time or trade it more rapidly.

If you’re a beginner, it can be tough to know when to sell your stock. In that case, it may be best to trade through a broker or financial advisor who can assist you. 

Note that some stocks may pay a dividend. This is a small payout the company makes each month, quarter, or year to anyone who owns their stock, though it can be suspended if the company feels they are in a financially difficult position (many companies suspended their dividends, temporarily, during the COVID-19 pandemic).  

Ultimately, however, there will always be risks involved with investing in the stock market as the price of your stock could plummet. In order to reduce risk, it can be wise to place your money in multiple stocks, instead of in just one particular company. Options: The Basics

An option is a contract, so it has a specific expiry date. Unlike stocks, which you can hold onto for years, options tend to appeal more to traders who want to buy and sell more regularly. But rather than making one decision regarding whether or not a stock will rise in value, an option requires more thought.

While you do need to have an opinion about the direction the stock is headed in, you also need to have an opinion regarding how high or low it will move from its current price, as well as the time frame in which that will happen. 

Essentially, when you invest in an option, you purchase the right to buy or sell a stock for a set price at a future date. You don’t have any direct ownership of the company at all. 

You can invest in two types of options, a call or a put. 

A call option gives you the right to buy a stock at a predetermined price on or before the option’s expiration date, while a put option gives you the right to sell a stock at a certain price on or before the option’s expiration date. 

When you invest in a call option, you and the seller both agree on the price you’d pay for the stock. You want the stock price to rise above the price you’ve agreed upon in your call option, however.

Then, you can exercise your option, buy the stock at the price you agreed upon, and sell it at the current price to realize a profit. Similarly, with a put option, you and a seller agree on a price for the stock but you want the stock to decline in price. Then, you can make a profit from selling your stock at a higher price than you could get for it at the stock market.

Evidently, options trading is a bit more complicated than simply buying or selling a stock. You need to actively be managing your portfolio. What’s more, you are obligated to buy or sell your stock at the agreed upon price at the expiration date, which can mean financial gains or losses.

Are Options Better than Stocks?

When it comes to choosing between options vs. stocks, it ultimately depends on what type of investor you are. If you want to actively manage your portfolio and are looking for short-term trading opportunities with high profit, an option may be for you. Alternatively, if you’re leaning towards long-term investments and are more of a beginner, a stock may be easier to start with. 

Stocks and options can both help you diversify your portfolio, meaning that having both can be useful, too, though there is a general consensus within the investment community that options are better than stocks.This is because options can be significantly more profitable than stocks, allowing you to buy stocks at a lower price than market value and sell them at a higher price.

Options can help minimize risk in many other ways, too. While there will always be inherent risk in investing, you can use a put option to sell your stock at a price that is higher than what it may plummet to, ensuring that your loss is minimal versus what it would have been if you bought the stock of that same company and didn’t have a put option. 

Finally, an option can also be traded prior to its expiration date, making options incredibly flexible, unlike a stock that has a fixed price at any given time.

Nevertheless, options trading must be hands-on and requires knowledge of the financial world and strong convictions about the movement and timing of a stock change. As such, while options may be more profitable than stocks and can be less risky, too, it may still not be the right option for you and your lifestyle.