Stock Trading or Stock Options Trading: Which is Best?
When the average person thinks of trading and the stock market, they tend to think of buying shares and selling them soon after for a profit. This is called Stock Trading, and yes, it can be quite an effective strategy for generating an income in a rising market.
But how does the trader adapt this strategy to a falling market?
Sure, there are creative ways to profit from actual shares in a falling market, such as buying and shorting shares, but many of those strategies involve high, unlimited risk, and that’s just not my style.
I’m far more comfortable with a limited, controlled risk, to generate a consistent income and with the strategies I use for this, my risk is always minimised.
Every trader has his or her own preferred trading vehicle, but from personal experience, Stock Options Trading offers the trader greater profitability at a much smaller cost.
And one of the most appealing benefits of Stock Options Trading is that you have the ability to profit from shares whether the stock price is going up or down. There are several reasons why I prefer to use stock options over other trading vehicles:
AFFORDABILITY:
Stock Options allow us to control large company stocks that would otherwise be quite expensive to own.
So you can actually profit on the same number of shares using a much smaller amount of money.
For example if XYZ shares were trading at $ 20 and you chose to buy 50 shares, your cost would be $ 1,000.
An XYZ Call Option with a strike price of $ 20 might only cost you $ 1 and if you used the same $ 1,000 to purchase Call Options instead, you would actually have control over 1,000 of the same shares, not just 50.
LEVERAGE:
Controlling and profiting from a larger investment using a much smaller amount of money initially, produces the power of leverage.
With Stock Options, not only are you able to control more shares, but your profitability would be much greater than buying the actual stocks.
Using the same example we used above, if you had bought 50 XYZ shares and they had increased to $ 40 then you would be looking at a profit of $ 1,000.
But if you had purchased XYZ $ 20 Call Options instead, they may now be worth $ 2.00 and you would be looking at a profit of $ 2,000.
You can precisely calculate the leverage of a call option, but this is dependant on where the current stock price is in relation to the option strike price.
For instance a call option that is ‘In The Money’ (Current Stock price is above the strike price) offers less leverage than a call option that is ‘Out Of The Money’ (current stock price is below the strike price).
INCOME:
Stock Options can be Purchased or Sold. When Options Trading, this offers you two ways to make money as income.
Writing Options - you can write (or sell) a call option and collect the premium as income.
When you write options, you are profiting from time decay because as an option draws nearer it’s expiry date, it loses value in time.
As a writer, you have an opposing view to the buyer, or taker of the option, and you stand to make the most money when the option expires worthless.
One thing to consider is that the taker of a Stock Option is not obligated to buy the underlying stock, but the writer (or seller) of a call option IS obligated to sell the underlying shares should the option taker exercise their right.
Regardless of the outcome however, the writer gets to keep the premium they originally receive.
Writing Stock Options on stocks you do not own can present an unlimited risk, so you should always exercise caution and understand entirely the strategy which you are implementing.
Short Term Options Trading - you can buy (or take) a Stock Option and profit when you on sell the option.
This would be the most common strategy involving Stock Options.
Options Trading is most profitable for the trader when the underlying stock price rises or falls (depending on which type of option is held) before the expiry date of the option.
As the share price increases, a Call Option goes up in value, and when a share price falls, a Put Option will also increase in value. Once the share price has moved in the desired direction, the trader can on sell their option to realise a profit.
Unlike the writer of a Stock Option, when buying (or taking) options you have no obligation to buy or sell the underlying stock.
The art of trading Stock Options means your maximum risk is limited to the amount which you paid for the option in the first place.