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. Stocks have the advantage of time on their side. Historically, equities have outperformed most other asset classes over time.
While it's possible to make quick profits through stock trading, in general, it tends to take time to make the biggest profits. If the market price of the stock rises above the strike price, the option is considered to be “in the money”. For the shareholder, if the stock price remains stable or falls, the loss is lower than that of the option holder. To make a net profit from the option, the stock has to exceed the strike price, enough to offset the premium paid to the call seller.
Almost 3 years ago, I wrote an article, Bet on Apple 9 to 2, which described a bet in which a 35% move in stocks returned 354% in the options trade. Stocks are said to be one of the riskiest types of investment because changes in the market can have a profound impact on the profitability of the issuing company itself. If you believe that the market price of the underlying stock will remain stable, trade lower, or lower, you can consider selling or “writing a call option.” An attraction for investors who want to speculate is that they can magnify the effects of stock movements, as indicated in the table above. As such, an investor can obtain an option position similar to a stock position, but with enormous cost savings.
In general, options trading is the responsibility of the active and practical trader looking for short-term profits. Call buyers generally expect the underlying stock to rise significantly, and buying a call option can provide greater potential gains than owning the stock directly. options and stocks are two ways to put money to work in the market, but they offer very different risk and reward profiles. A call option is a contract that gives the owner the option, but not the requirement, to buy a specific underlying stock at a predetermined price (known as the “strike price”) within a certain period of time (or “expiration”).
Options are a much more difficult investment than stocks because they require you to be right both in the direction and timing of future price movement. Now that you understand the different roles that stocks and options can play in your investment portfolio, hopefully it becomes clearer that trading stocks and trading options requires two different sets of learning tools and skills. Because the performance of individual stocks can be volatile day by day, experts generally recommend investing in stocks with money you won't need for at least five years. That applies if you plan to hold a stock for years or try your hand at day trading by actively buying and selling stocks over short periods of time, such as days or weeks.