There are situations where buying options is riskier than owning stocks, but there are also times when options can be used to reduce risk. It really depends on how you use them. Options can be less risky for investors because they require less financial commitment than stocks, and they can also be less risky because of their relative impermeability to the potentially catastrophic effects of gap openings. While investors can certainly trade options alongside stocks, call options also confer some unique risks.
An option loses all its value after a certain date, while stocks tend to hold their value indefinitely. As we mentioned, options trading can be riskier than stocks. But when done correctly, it has the potential to be more profitable than traditional equity investment or can serve as an effective hedge against market volatility. Creating a portfolio once you understand the difference between stocks and options is still like going out to eat at a restaurant.
Options investors can lose the full amount of their investment or more in a relatively short period of time. When you buy a call option from the option maker or seller, both agree on the strike price or what they would pay to buy the underlying stock. The biggest difference between options and stocks is that stocks represent ownership shares in individual companies, while options are contracts with other investors that allow you to bet in the direction in which you think the stock price is heading. For novice investors, and especially for people with a long-term strategy, stocks are a more common entry point to the stock market than options, because they are simpler, tend to have lower expenses, and allow a zero-intervention approach.
Put options entitle you to sell shares at a certain price on or before the option expiration date. Call and put options are attractive to investors only if the market for those options is liquid enough, which means that options can be easily bought or sold. An option specifies a predetermined price at which the security can be bought or sold and a predetermined expiration date, after which the option has no value. Those who are in favor of an active investment approach and love to watch the market can find attractive options.
In addition, some options strategies are riskier than others, so make sure you understand the trade beforehand. Options investors can lose the full amount of their investment in a relatively short period of time. In general terms, options are riskier than stocks because they are derivative securities with typically greater price volatility. On the other hand, if you are more of an active and practical trader, then options might be something to consider.
Any investor should ensure that they have significant knowledge about options and their risks before committing capital to these complex derivative securities. Stocks and options can offer drastically different returns and risks for investors, and those who invest in any of them should understand how they work before getting involved. They've been around for more than 40 years, but options are starting to get the attention they deserve.