Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
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Stocks and options are two of the most popular investment types that investors might include in their portfolio. There are reasons to invest in each, and they both come with their own risks, timelines, pros, and cons.
When deciding whether to invest in stocks vs. options, or any type of security or asset, it’s important to consider your personal investing goals, experience, risk tolerance, and investing horizon.
Key Points
• Options are derivatives that provide the right, but not the obligation, to buy or sell a stock at a set price before a certain date.
• Stocks represent shares of ownership in a company, potentially offering dividends and voting rights.
• Options can offer high leverage, allowing significant exposure to stock price movements without full investment in the stock.
• The value of options can decrease rapidly over time due to time decay, especially as expiration approaches.
• Stocks can be held indefinitely, providing potential for long-term gains, whereas options have an expiration date limiting their lifespan.
What Are the Differences Between Options and Stocks?
Stocks represent ownership in a company, whereas options are derivative contracts that give purchasers the right, but not the obligation, to buy or sell shares at a set price before expiration. Note that sellers of option contracts are obligated to fulfill the terms of a contract if a buyer chooses to exercise it.
| Stocks | Options | |
|---|---|---|
| Common types of Investors | All levels of investors, including beginners and long-term investors | Experienced and active traders |
| Potential Downsides | Risk of loss, taxes, fees | Potential higher risk of loss, complexity, taxes, and fees |
| Type of Investment | Equity | Derivative |
Options
Options, or stock options, are a type of derivative. Rather than buying shares of a company, options contracts give buyers the right, but not the obligation, to buy or sell shares at a specified price (known as the strike price in options terminology) at a specified time in the future.
A call option gives the buyer the right, but not the obligation, to buy a stock at a specified price, at a specified time in the future. The options investor does not have any ownership of the company’s shares unless they choose to exercise the option and buy the shares.
A put option gives the buyer the right, but not the obligation, to sell a stock at a specified price, at a specified time in the future.
Over the time period of the option, a portion of the contract’s value (its extrinsic value) typically gets exponentially less valuable. This is known as time decay.
Investors may exercise their right to buy or sell a stock, or sell their option position to make a potential profit. Options trading strategies can get complicated, involving buying and selling multiple options on the same underlying security.
Recommended: A Guide to Options Trading
Stocks
Stocks are portions of ownership in companies, also known as shares. Investors can buy shares in companies and become fractional owners of that company in proportion to the number of outstanding shares that company has. For instance, if a company has 100,000 shares and an investor buys 1,000, they own 1% of the company.
Investors who purchase stocks typically hope to buy them at a lower price then sell them later at a higher price to make a profit. There are also other ways investors might earn profits on stocks. For instance, some stocks pay out dividends to owners. Every month, quarter, or year, an investor may receive a dividend payment based on the number of shares they own and the company’s decision to pay out dividends to shareholders.
Recommended: How to Start Investing in Stocks
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
*Check out the OCC Options Disclosure Document.
5 Key Differences in Stocks vs Options
Both stocks and options are popular investments, and there can be a place for both of them in a diversified portfolio. Here’s a look at some of the differences to keep in mind when it comes to trading options vs. stocks:
1. Risk
Both stocks and options have associated risks. For stocks, the risk is that the value of the security may fall lower than the investor expected. For options, there are additional risks, including the risk that they could exacerbate losses or could expire worthless.
2. Ownership
When an investor buys stock, they become partial owners of that company. When they buy options, they purchase the right (but not the obligation) to purchase shares at a predetermined price by an agreed-upon date.
3. Quantities
When buying stock, the number of shares an investor buys is the total number they have, and they can purchase any number of shares, including fractional shares. When buying options, each contract typically represents 100 shares of stock.
4. Timeline
Options are contracts that are only valid until the expiration date. They may lose value over time and be worthless when the contract expires. When an investor buys stock, they can hold it as long as they want.
5. Time Commitment
Investors can buy stock and hold onto it without doing much additional work, whereas options traders are often more hands-on, keeping an eye on the market for the duration of the contract, since options expire on a set date and may gain or lose value over that time period.
When to Consider Trading Stocks
There are several reasons to consider trading stocks, depending on your goals, timeline, and risk tolerance. Like any asset, stocks come with their share of risks and downsides.
Pros
Stocks may be easier for investors to research than options, given that each stock represents a single security with a long pricing history. Options, conversely, often involve complex strategies and require advanced skills. There are several other benefits as well:
• Investors don’t have to sell their stocks on any particular date, so they can choose when the appropriate time is to sell.
• Some stocks pay out dividends to investors.
• Stocks may be easier to research than options since they tend to be less complex than options strategies.
• Being a shareholder may allow investors to vote on certain corporate issues that could affect their investment.
• Stocks typically have more consistent liquidity than many options contracts, meaning it may be easier for traders to buy and sell them quickly.
Cons
As with all securities, there are risks involved with investing in stocks. These may include, but are not limited to:
• Whether you buy and sell stocks quickly as a day trading strategy, or hold onto them for years, you may need to pay short- or long-term capital gains taxes if you sell for a profit.
• Although trading stocks has the potential to be profitable (as well as high risk), stocks are generally used as part of a long-term buy-and-hold investing strategy for most people.
• Assuming a level of shorter-term volatility, it can be emotionally challenging to watch the market and one’s portfolio go up and down in value over months or even years.
• When investing in stocks, traders face the possibility of losing some or all of their investment.
• Stock prices may be high or low depending on the company, which could make it difficult for smaller traders to buy more expensive shares (unless fractional shares are available).
When to Consider Trading Options
Like stocks or any investment, options come with their share of risks and downsides. Options are often used for leverage, income strategies, or hedging, but they generally require a higher risk tolerance and more active engagement.
Pros
Options trading can be complicated, but there can be significant upside potential. Benefits include:
• Options provide investors with leverage, which offers the ability to control a larger number of shares of the underlying asset with a relatively smaller amount of capital. While this may amplify potential profits, it amplifies potential losses as well.
• As a result of leverage, options may require relatively less money to participate in the market, though they come with a potential higher risk of loss.
• Options may help hedge against market volatility, such as by using protective puts to limit downside risk.
Cons
Options trading is higher risk and involves an advanced skill set. Also, since fewer traders buy and sell options than stocks, there may be lower liquidity, sometimes making it difficult to get out of an options contract. Other drawbacks may include:
• If the stock does not move as expected and the option expires unexercised, the investor loses the premium paid.
• Options tend to lose value over time because each contract has a fixed expiration date, and the time component of its price decreases as that date approaches.
• Trading options may require more ongoing management than stocks because traders must monitor expiration dates, volatility changes, and potential assignment risk.
As mentioned above, options trading involves leverage, which comes with the risk of seeing amplified losses as well as potentially amplified gains.
The Takeaway
Stocks and options are two types of investments traders use to seek potential profits and build a diversified portfolio. Depending on your investment strategy, you may decide to invest in a combination of the two. Note that both have their own associated risks and potential benefits.
Options trading, however, is typically something that experienced investors delve into, generally requiring traders to actively invest, rather than leave their portfolios idle. If you’re interested in options, it may be helpful to speak with a financial professional for guidance.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
FAQ
What is the fundamental difference between stocks and options?
Stocks represent fractional ownership in a company, which may offer dividends and voting rights. In contrast, options are derivative contracts that give the purchaser the right, but not the obligation, to buy or sell shares of the contract’s underlying asset at a predetermined price (called the strike price) by a specific expiration date. Options trading is generally considered higher risk compared to stock investments.
How does the risk profile differ between trading stocks and options?
While both investments carry the risk of financial loss, options generally involve more complexity and higher risk. For example, the leverage involved in options trading may amplify both gains and losses, and options may expire worthless. Stocks are primarily subject to the risk that the security could lose value, which may result in the loss of principal invested.
Do stocks and options offer the same flexibility regarding time commitments?
No. When an investor buys stock, they can hold those shares indefinitely. Options, however, have a limited lifespan and expire on a specific date, called the expiration date. As a result, options typically require more active, hands-on management from traders to monitor market conditions, the price of their option, and expiration timelines.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Options involve substantial risk of loss and the possibility an investor may lose the entire amount invested. Before starting options trading, investors should be familiar with the Characteristics and Risks of Standardized Options . TTax implications with options should be considered. Consult your tax advisor to understand any impacts to your taxes.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Investment Risk: Diversification can help reduce some investment risk, but cannot guarantee profit nor fully protect in a down market.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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