Small business owners not only work for the present but also work for the future. Many owners choose to invest in the financial markets. However, not everybody understands the different choices available to them. For example, if you are ready to invest you’ll have to choose between options vs stocks. What are the differences between them?
We hope our series of investment advice helps you maximize your business potential. You can also check out 101 on the Stock Market to get a holistic understanding of the subject and geta ll the resources you need as a beginner in the world of financial investment.
Options vs Stocks: What Are Options?
Options contracts give you the right to buy or sell something at a given price. These contracts remain open for a certain amount of time.
Imagine a farmer wants to sell his grain. Prices will often fluctuate throughout the year. He wants to make sure that he can lock in today’s prices for anything he produces in the next year. A put option contract gives him the right to sell his grain at a given price for a time limit his choosing.
It’s best to think of options contracts as insurance products. They allow you to buy protection in the markets to the upside and downside.
Options contracts come in two types.
Puts – Puts give the purchaser the right to sell a stock or other financial instrument at a given price. These contracts are available to the purchaser until the expiration time. Puts are often used as bets of a stock going down.
Calls– Calls give the purchaser the right to buy a stock or other financial instrument at a given price. These contracts are available to the purchaser until the expiration time. Calls are often used as bets of a stock going up.
You should understand the major benefits and risks associated with options.
- Provides leverage (you control more stock for less upfront cost)
- Flexible in deciding what price and expiration period you want
- Widely available and easy to trade in the major exchanges
- The risk is limited to the premium you pay
- Leverage means you can lose a lot quickly
- Options lose value over time, all things being equal
- You have no right to dividends or shareholder voting
- Options can be difficult to understand for beginners
Most people don’t realize they can actually buy and sell options. Option products act a lot like insurance. For insurance companies to make money, the claims they pay must be lower than the number of premiums they collect. The same is true for options.
Consequently, option sellers start with a statistical edge of profitability over buyers.
Options vs Stocks: What Are Stocks?
Stocks are partial ownership of a company. The amount of the company you own is proportional to shares you own to the total available. Owning shares of a company allows you to share in their profits, but also their losses.
Electronic trading allowed average investors to buy shares of publicly traded companies at reduced costs. An industry that was once captive to the elite few is now open to nearly everyone.
Stocks come in a few flavors:
Common shares – This is the most typical type of stock. Common shares give you ownership of the company. They entitle you to dividends and voting rights. However, if a company goes bankrupt, they are the last in line to be paid out.
Preferred shares – These shares don’t have voting rights like common shareholders. However, they generally receive substantially higher dividends that remain consistent. Unfortunately, they rarely appreciate much in value over time.
American Depository Receipt (ADR or ADS) – When international companies trade on the U.S. exchanges, they use intermediaries. These intermediaries have direct ownership in that companies home country. The intermediary issues shares on the American exchanges that tie to their foreign ownership.
If stocks are so great, why doesn’t everyone own them? Let’s understand the pluses and minuses.
- Stocks can be purchased easily from your home computer
- Ownership allows you voting rights in the direction of the company
- Over time stocks will outperform bonds. The S&P 500 returns 8%-12% per year on average.
- If you don’t have enough money, it can be difficult to diversify away the company-specific risk
- Researching a business can be difficult and require financial knowledge
- Stocks can have significant drops. The Great Recession saw the overall market drop by over 50%
- You have the potential to lose your entire investment
If you decide stocks are a feasible option for you, make sure to read How to invest in the stock market before proceeding.
Options vs. Stocks at a Glance
Now that we have a good understanding of the products, let’s recap them side by side.
|Stocks vs. Options||Stocks||Options|
|Eligible for Bankruptcy Compensation||Yes||No|
|Easy to understand||Yes||No|
|Flexibility for advanced trading||No||Yes|
|Ownership of the Company||Yes||No|
Options vs Stocks: What Should You Choose?
When it comes to deciding between options vs stocks, most investors will gravitate towards the second. They know them, hear about them, and are comfortable with them. But, most won’t do the research to select good stocks. Picking the right stocks requires doing your homework. You need to understand the company based on both their financial performance, as well as their market price action.
Although options may appear complex, the basics of them are straightforward. However, they lose value over time. With an option, you have to be right both in direction and time. Direct stock ownership gives you much more time. You find a lot of people trading options to make a quick buck. But, many advanced traders make money far more consistently selling options than they do by owning stocks.
Which you choose ultimately comes down to a few considerations:
- How much time do you have to spend learning and researching?
- How much are you prepared to lose?
- What’s the purpose of this investment?
- How much risk do you want to take?
Make sure you understand one thing: when it comes to deciding between options vs stocks, both choices come with risk. It’s important not to take out loans to make speculative investments in stocks. However, that doesn’t mean you shouldn’t use the cash provided by a business loan to invest wisely in your business. Check out our business loan calculator to see how a business loan could provide you the cash to invest in your business, improve it and grow it.
Markets can and do change. Internet companies did really well until they crashed in 2000. Banks were great investments until 2007. Regardless of which you use, it’s important to diversify your portfolio. You don’t need to own just stocks or options. Many investors hold bonds, currencies, commodities, and more.
A great place to start is exchange-traded funds (ETFs) or mutual funds. These allow you to purchase shares of a fund that diversifies your holdings for you. It’s a fantastic option for small business owners to participate in the market at a low cost.
At Camino Financial we take our motto No Business Left Behind to the heart. We work hard to make sure small business owners have the tools and information necessary to be as successful as possible.
Growing your business is goal number one. When you’ve built a sizable business, investing in the market will naturally follow. There’s no better way to grow your business than maximizing your potential sales. Consider applying for a loan to get started on growing your business safely and steadily.