Stock Trading And Trading Options -
Which is best for you?

What is the difference between Stock trading and trading options? In this article I'll be sharing an introduction to trading options and give you some basic examples of what options are and how you can use them to enhance the returns from your investments.

Many people can't decide whether Stock trading or trading options is the best way to go. Trading shares on the stock market has become a daily or at least weekly pastime for many people. 

But, like any financial investment, trading stocks can be risky if you don't know what you are doing. The price can fall unexpectedly and stay down for lengthy periods (sometimes forever). 

To offset that risk, and to trade with more funds than you have without borrowing, options are... well, an option. The main difference between Stock trading and trading options is that you may never actually own the stock (or indeed any other commodity), but you can participate in it's movement with a small deposit instead of making a large investment in cash.

An option is a contract giving you as an investor the right to buy or sell a financial instrument at a given price on or before a certain date (called the expiry date).

Options contracts are created (or written) on all sorts of underlying assets: real property, stocks, bonds, even movie screenplays. (Though the latter trade on a rather different sort of exchange...)

The basic idea of options trading is simple...

Invest a (relatively) small sum today, to control something worth a larger amount today. Your assumption is that the price will move in a given direction before a certain date, then sell and pocket the difference (hopefully a profit).

For example, suppose Google shares are selling at $400 per share. But buying 1,000 shares of GOOG (the symbol for Google stock) at $400 each would cost $400,000. That's a substantial investment of cash, one beyond the means of the average investor.

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Even buying stocks using a margin (borrowing a percentage of the purchase price to fund your investment) would typically get you only half the way there. Most stock brokers will lend their clients only up to 50% of the total cost. (There are laws restricting them, in any case.)

But, you can still 'own' 1,000 shares of GOOG. Simply buy an option at, say, $20 per share (the 'premium'). Now your investment is $20,000 - hefty, but within reach. (That's called 'leverage' - controlling more than you own.)

Every option has an expiration date - the date by which the investor must 'exercise his option', i.e. execute a decision to buy/sell the instrument or lose his invested money. Depending on the underlying asset, and other factors, the date can be anywhere from a day to several months hence.

Options also have a strike price - the price at which the underlying
instrument has to be bought or sold when exercising the option.

Continuing the example, suppose the option for GOOG expires in 30 days and has a strike price of $410. The break-even price would be $410 + $20 = $430 per share. At this point, you are 'under water' by $30 per share x 1,000 shares = $30,000. Ouch!

(Note: 'Under water' is - obviously - not the same amount as your investment. It's the amount you have to rise to reach break-even.) 

But, three weeks pass and Google announces some good news about earnings. The price per share rises to $440. Now you can exercise your option ('close your position') and sell.

The options contract price has increased as well, to $25. Your profit is: ($25-$20) x 1,000 = $5,000. (Ignoring broker fees.) Not bad. That's a 25% profit on a $20,000 investment. (Of course, prices fall as well. More on risk and hedging strategies later.)

So, should you be Stock trading or options trading?

Options aren't for everyone. They're more complicated (though not too much), riskier, and generally involve shorter term trades and the requirement to watch the market more closely.

But note that purchasing the options contract did NOT involve investing 5% ($20/$400 x 100%) and borrowing 95% of the funds. Options contracts are a straight investment of funds, not a broker loan.

If the price goes in the predicted direction before expiration, you make money. Otherwise, you lose (some or all of) your investment.

As with any investment, do your homework. Make sure you understand how options work and what the relative risks are. In particular, study the market for that type of underlying instrument. Throwing darts blindly is the least successful options trading strategy.

No matter whether you are Stock trading or options trading, good luck... or should we say, good research is the name of the game...

And if you'd like to cut out all the hype and B.S. about learning to trade options and learn EXACTLY how to do it right from an expert, check out The Options University.

Your membership includes everything you need to start trading options profitably TODAY! Visit The Options University today...

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The options trading and technical analysis information shared on this website is for educational purposes only and is not an invitation to buy or sell securities. While everything here is believed to be accurate, it should not be considered solely reliable for use in making actual investment decisions. Trading options is a risky business and you can lose more than your original capital. Always consult a licensed broker or adviser before trading the market.

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