Why Stock Is More Risky Than Options!

By: David Chandler..

We prefer to trade in options rather than stock.

But you have probably been told or read that options are risky. Even worse, that you can lose your shirt trading them!

How do you know which is the truth?

Let's take a look at stock ownership. What can happen if you buy stock?

The price can go up.

The stock price goes down.

Its value can go sideways.

If the value goes up you make money. If it goes down you lose money.

However if there is sideways movement you will not directly gain or lose money. You will however incur costs through brokerage fees directly and indirectly lose money through what is know as "opportunity cost."

This is where you are unable to invest in new opportunities and therefore miss out on the potential profit.

So if you purchase stock you can only make money if the stock price goes up.

OK, the next possibility is short selling stock.

Again this is another possibility but is does involve some complicated strategies coupled with uncapped risk. Based on this it is not an approach we would recommend.

Shorting stock requires you to sell stock you do not own with the intention to purchase it back at a value less than you paid. It's the difference in value that makes you the profit.

But can you see what the problem is here?

Well what happens if the stock price goes up? Particularly if it goes up a lot?

Having traded the stock at a lower value when you have to buy it back it costs you more resulting in losses which can be catastrophic.

Once again you can only make money when trading in stock if the value increases.

You also need to consider another aspect of owning stock and that is the cost; it can be very expensive.

Consider buying 200 shares at $25 the cost would be $5000. Should you buy at on the margin it will still cost $2500.

In anyone's money that's a lot to find; it's also a lot to risk based on the fact that you only have a 33% chance of making a profit.

You also have to consider in the equation the fact that stocks don't trend in away you can guarantee a profitable return all that often. So you have to be able to pick the right time to invest.

We can conclude that successfully trading in stock is expensive and difficult to do.

A good alternative is buying options.

For a start you only have to invest about 2% of what the stock was worth and yet you still control the same 100 shares.

So in the example above, instead of investing $5000, we might only have to outlay $100.

Plus, if you select the right strategy, you can profit no matter whether the stock price goes up; goes down or even goes sideways!

And finally, your risk is limited. The maximum you can lose is the amount you put into the trade. So in the example above - $100.

But the best thing of all is the leverage that options provide.

Once again taking the above example, to get an increase of around $5 would result in a 10% profit or 20% on a margin.

But with this increase in stock price the value of the option might increase by 100%. And so the profit on the trade would be 100% - or ten times that of the straight stock trade.

In conclusion don't limit your options by accepting the standard view that stock ownership is the safe way to go and trading in options is the high risk game. By understanding options and the ways to trade them you can see good returns on your investment.

The above comments are offered for educational purposes only. We are not providing you with financial advice. We are simply sharing with you what has and hasn't worked for us personally. If you wish to trade or invest in the stock market you should obtain advice from a registered licensed advisor.

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