Stock vs. Stock Options

I often associate the investor education space with the health and fitness business.

There are so many tricks and fads … taking advantage of those poor uniformed souls who are just trying to improve their lives. The only thing that really bothers me … is when I read articles or see commenters say that options are a fool’s game.

Sure, option investing isn’t for everyone … however, if you’re investing in stocks … and you’re not using stock options to express your market sentiment … you’re doing something wrong. The chances of a stock going up or down is 50/50.

However, with options you can structure trades that skew the probability more in your favor.

In most cases, using options instead of buying total stocks is a better deal … not to mention the ability to change the odds on your court.

Why?

First, options are leveraged instruments.

That means you need less capital to get started. For example, a stock option contract allows you to take advantage of 100 shares. Let’s say AMNZ is trading at $ 337.49 per share (hypothetical situation).

For $ 33,749 you can buy 100 shares (not including commissions and fees). On the other hand, you could buy a call option … controlling the same number of shares for a total less.

Let’s say you had a bullish bias and bought a call option of SEP $ 320 for $ 2,900 (expiring in 76 days). In very simplistic terms, this SEP $ 320 option will earn $ 67 for every dollar that rises in the share price.

If instead you had all 100 shares … your PnL would be $ 100 higher for every dollar higher in the share price.

However, look at how much more capital it takes to buy the shares … more than 11 times the amount of money.

In fact, if the stock investor bought 10 shares for $ 3,374.90 … they would only earn $ 10 for every dollar the stock price went up … lead options.

Options give you the opportunity to diversify your portfolio of stocks.

In the example above, an investor would have to shell out nearly $ 34,000 for 100 shares of AMNZ.

If they had a small trading account … it would be very difficult for them to diversify due to the huge capital absorbing the costs of buying stocks.

An investor with a portfolio of $ 25,000 can do A LOT more with options in terms of diversification and profit potential (from leverage). Using stocks instead of options is a misuse of capital … and hurts the small investor who wants to have a balanced and diversified portfolio.

Additionally, call options and structured option trading define and limit risk.

For example, when you buy a stock … your risk is limited to your initial investment. In this case, the risk is $ 33,749.

Of course, the probability of AMNZ reaching zero is highly unlikely.

However, if you’ve been through the dot-com bubble and the most recent financial crisis … you know that anything is possible. With the purchase option of SEP $ 320 … the total risk of the operation is $ 2900.

Not only that, but the long call option enjoys the same benefits as the long stock position, that is, indefinite profit potential.

A more realistic fear than AMNZ going to zero is a mini-flash crash. The show and high-frequency trading play a big role in the US stock market.One has only to look at the funky events at Anadarko Petroleum Corporation (APC) last year to see just how powerful they are.

“On May 17, 2013, in the closing seconds of trading, Anadarko Petroleum Corporation shares (symbol APC, market capitalization $ 45 billion) traded from $ 90 to $ 0.01 in 45 milliseconds. Wow. This it may just be a record – losing $ 1 trillion per millisecond. That’s a rate of $ 1 trillion per second. Now this is something Congress will understand. Perhaps the NYSE should have kept its LRP circuit breakers after all? ”

Now, if you are a long-term investor, it is highly likely that none of this really influences the way you invest. However, it could be if you are a responsible trader … who has stops to limit losses.

How annoying would you be if there was a mini-flash crash in the action you’re in … and you stop it … just to watch the action rebound? This is a very real concern.

Of course in the case of APC … a lot of those bad price impressions were smashed … but I have heard horror stories from traders who have lost real money to these mini flash accidents. It is much more relaxing … to be in an option position … where you have a defined and limited risk.

But the options are not too complicated …

With options, you can express your opinion about the market in many different ways.

For example, there is a strategy when you think a stock will stay flat … not only that, but you can be very precise … especially in the magnitude of the stock price movement: a little higher to a lot higher , a little lower to a lot lower.

As you move forward and become more comfortable with the options … there are strategies that express range limit movement … and even non-directional strategies that focus on your views on volatility.

Heck … there are times when I made a profit on a position even though I was totally wrong in my assumption.

I would have lost money if I owned the underlying, but because I used options and structured trading that gave me the opportunity to make money even if I was wrong.

Options give you the flexibility to position yourself in all market conditions

Stocks can go up, down, or trade sideways. However, if you buy a share, you can only make money if the share price increases. On the other hand, if you have few stocks, you can only make money if the stock price goes down. If stocks are traded sideways … you don’t make money.

With options, you can take advantage of those situations too.

The possibilities are truly limitless. But the key is not to be afraid of investing in options. Sure, if you are reckless and irresponsible … you can lose money quickly.

That should go without saying … but if you learn the right approach … and build a foundation … investing in options will trump investing in stocks most of the time.

Let’s face it, the people who put you off options are the ones who don’t fully understand them. And trust me, if you don’t have the time or patience to understand the options … you should probably steer clear.

Investing in stocks is like driving a Ford Pinto … it will get you from point A to B … and you will have no problem handing it over to your 16-year-old son when he is practicing for his driving test.

Option Investing is like a Ferrari GTE Spider … a powerful and sophisticated machine with multiple gears … something you wouldn’t dare let your 16-year-old take for a spin on the street.

Are you a stock investor looking to jump into options?

If so, I’d love to hear your reservations about why you haven’t taken the plunge.

Also, if you are new to options, I would like to know how you are doing so far … what has been your biggest hurdle so far?