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.
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 | Options | |
|---|---|---|
| Common types of Investors | Beginners and long-term investors | Experienced and active traders |
| Potential Downsides | Risks, Taxes, Fees | Risks, Costs, Complexity |
| Type of Investment | Equity | Derivative |
Options
Options, or stock options, are a type of derivative investment. 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, the contract 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 10,000, they own 10% 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 can earn profits on stocks. For instance, some stocks pay out dividends to owners. Every month, quarter, or year, an investor can earn money based on the number of shares they own.
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 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 will fall lower than the investor expected. For options, there are additional risks, including the risk that they could exacerbate losses or could expire without being exercised.
2. Ownership
When an investor buys stock, they become partial owners of that company. When they buy options, they do not.
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 represents 100 shares of stock.
4. Timeline
Options are contracts that are only valid for a certain period of time until the expiration date. They lose value over time until they are 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 and prefer an eye on the market for the duration of the contract.
💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
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. Some of the pros and cons of stocks include:
Pros
It can be relatively easy to start investing in stocks. There are several other benefits as well:
• Investors don’t have to sell their stocks on any particular date, so they can choose the best time to sell.
• Some stocks pay out dividends to investors.
• Stocks are easier to research than options since they have market history.
• Being an owner of a company may allow investors to vote on certain corporate issues that can affect their investment.
• Stocks typically have more liquidity than options, meaning it’s easier for traders to buy and sell them at any given time.
Cons
Like all securities, there are risks involved with investing in stocks. Those include:
• Whether you buy and sell stocks quickly as a day trading strategy, or hold onto them for years, you will need to pay short or long-term capital gains taxes if you sell for a profit.
• While trading stocks can be very profitable, it’s generally considered a long-term strategy.
• It can be emotionally challenging to watch the market, and one’s portfolio, go up and down in value over months or years.
• Making a big profit on stocks can require a large upfront investment.
• When investing in stocks, traders risk losing all the money they put in.
• Stocks of certain companies are very expensive, making it difficult for smaller traders to even buy one.
When to Consider Trading Options
Like stocks or any investment, options come with their share of risks and downsides. Some of the main pros and cons of trading options are:
Pros
Options trading can be complicated, but there can be significant upside potential. Benefits include:
• Options may be an inexpensive way to participate in the market.
• Options provide investors with leverage. Essentially the investor has some control and access to shares.
• Options can help hedge against market volatility.
Cons
Since fewer traders buy and sell options than stocks, there can be lower liquidity making it difficult to get out of an options contract. Other drawbacks include:
• If an investor buys a stock option, they must pay a premium to enter into the contract. If the stock doesn’t move the way they hope it will and they choose not to exercise the option, they lose that premium they had put in.
• Options lose value over time.
• Trading options may require more ongoing management than stocks.
💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options trading account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.
The Takeaway
Stocks and options are two popular types of investments traders use to earn profits and build a diversified portfolio. Depending on your investment strategy, you might 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, and often requires traders to actively invest, rather than leave their portfolios idle. If you’re interested in options, it may be a good idea to speak with a financial professional for guidance.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
Photo credit: iStock/fizkes
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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. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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