When we talk about the financial market, there are various instruments. Some you would have heard of and even traded or invested in, and some can be new to explore. The two most popular instruments are options and shares.
When you invest in shares, you represent ownership in the company and earn profits through dividends. While option trading gives you the right to purchase or sell an underlying stock or other security at a specified price and on a specific future date. The risk and reward profiles of both instruments are different, which we will cover in this article.
What is Option Trading?
An option is a derivative contract, where you can trade different instruments as underlying assets at a predetermined price (also known as the strike price) on a future date. This can be stocks, ETFs, etc. There is no obligation to execute option contracts if the trade is not profitable. The seller collects a small fee, also known as a premium from the buyer for granting the option.
Option trading is divided into two types: call options and put options.
Call Option allows you to purchase an underlying asset at a specific price until a certain date. To earn profits from a call option, you would prefer that the underlying asset or security price rises. It means while buying a call option, you expect the asset price will rise.
While the put option is just the opposite, it gives you the right but not an obligation to sell the underlying asset at a specific price before the expiration date. In the put option, you can earn profits if the underlying asset or securities prices fall in the future.
What is Investing in Shares?
In a company, shares are units of ownership. When you buy a share, you can earn profits in the form of dividends and returns in the form of the share price going up.
The goal is to invest in shares at a lower price and then sell them at a higher price and is a long-term strategy for portfolio diversification across sectors and industries.
This is a great instrument for investors just starting their journey. It also helps in building long-term wealth for goals such as buying a house or saving for retirement.
Option Trading vs. Investing in Shares
Let’s understand the difference between option trading and investing in shares.
| Options | Shares | |
| Risk | High risk as they may expire without even being exercised. | Comparatively less risky than options if invested with good research and analysis. |
| Time Horizon | Most of the option contracts expire within days, weeks, or months. | Shares are generally invested for a long term from months to years. |
| Complexity | Options can be difficult to understand, especially for beginners. | Shares are fairly easy to understand and simple to buy. |
| Active Management | Option trading requires active decision-making and continuous monitoring. | Shares do not require constant tracking and monitoring if invested for the long term. |
| Capital requirement | You get high leverage means you can take large positions even with a smaller capital. | The initial capital required usually is the same as the stock price. |
It can be said that options are generally suitable for experienced traders because it is risky and requires analysis and deeper understanding. New investors or those looking for long-term wealth creation may not find it suitable. On the other hand, shares are easy to understand for beginners. The decision on whether to trade options or invest in shares depends on what goal one wishes to achieve.
Conclusion
Shares and Options can provide you with significantly different returns and risks. You should be aware of how they work and choose accordingly. If you want to start trading in options or wish to invest in shares, you can visit Dhan. Dhan is one of the best investment platforms that can make your journey smoother.
