When you are starting in the stock market, you are presented with a variety of financial assets to trade. Stocks are the most obvious choice traders make. But did you know that there is a way you can trade stocks at a marginal cost without owning them?
It is possible with options trading. But what is the difference between options and stock trading and how to choose one? Read on to find out.
What is the difference between Option Trading & Stock Trading?
Stock trading involves buying shares of a company, which provides fractional ownership of the company to the trader/investor. The rise and fall of stock value depend on the performance of the company and the demand and supply of stock in the market.
On the other hand, options trading enables buyers to have the right but not the obligation to buy or sell the underlying asset, which is stocks in this case, before/when the contract expires at a fixed price. The value of the options contract declines as it nears expiry. The price of the stocks also affects the price of the options contract.
If you have a decent appetite for risk and rewards but want to start small, option trading may be your best choice.
Advantages of Options Trading Over Stock Trading
Before starting with options, you must remember that vigilance and research are key. With proper research and sensible capital allocation, options can raise your returns while reducing risk. These are five advantages of options trading over stock trading:
With options, you can control more stock with the same amount of money using the power of leverage. For example, you need Rs 5,000 to purchase 500 shares worth Rs 10 each. However, if you choose to trade options, you can buy two call options for Rs 50, representing 100 shares each. You get access to 200 shares at the cost (premium) of just Rs 100.
2. Less Risky (When Used Wisely)
Considering the above example, if you own 500 shares of a stock and the market takes a dip, you end up at a loss of Rs 5,000. However, as an options buyer, your loss would be limited to the amount of premium paid, i.e, Rs 100.
Remember that while options allow you to hedge the risk, they are also highly prone to price volatility. Do your research to trade the right options.
3. Decent Gains
If the market is in your favor, the potential to receive a decent percentage of return increases for an options trader. If the stock price increases significantly, the buyer of a call option receives better profit than the owners of the stock.
4. More Strategic
Options allow the scope of being more strategic. Platforms like Dhan provide the benefits of live market tracking, a calculator, and pre built option trading strategies for a smooth and strategic trading experience.
5. Allows Hedging
Options enable traders to hedge against downside movements in stock prices. For example, a trader can buy a put option if he/she thinks the price of the underlying stock is going to fall. The put option will rise in price and the trader will benefit from the same. On the other hand, for stocks, there are no hedging benefits.
Option trading and stock trading are both great ways to ride the price movements in the stock market. However, options may be well-suited to traders who want to leverage smaller funds for larger trades.