Option and Stock Trading -Which is Suitable for You?

Option and Stock Trading, Knowing The Differences

It is a common notion among people who trade option to view option as just a proxy of the underlying stock. Is it really that simple? The answer is yes and no. An aspiring trader must understand the characteristics and the difference between the two instruments in order to be a successful trader.

Time Decay of Option. One of the major differences between the option and stock is that option is very much affected by time factor as it has the time premium component embedded into the total price. Depending on which side of the trade you are on in an option trade, time decay occurs as an advantage (to the seller) or disadvantage (to the buyer) regardless of the stock movement.

Rate of Time Decay. Option trader must be aware of the characteristics of option with respect to time-to-expiration. The steeper decay occurs when the expiration date approaches in the final month.

In general, if an option trader wishes to place a bet on the upward movement of a stock, but chooses to buy the option (limiting risk and increases leverage) instead of the stock, a suggested approach will be to buy long dated option (option that has at least two months or more till expiration, longer is better but liquidity may be a problem) which will have a more gradual time decay, with the view that the upward price movement of the shares more than offsetting the time decay. In addition, buying long dated option also allow more time for the stock to perform from the point of purchase till the expiration of the option.

However, if the trader wishes to have time decay on his side, he may choose to sell a short dated (8 weeks or

As an option buyer, your best scenario occurs when the movement of the underlying stock well exceeded the time decay of the option. At the other end of the trade, the option seller will do well if the underlying move in the direction to his advantage and do fine even as the underlying stock stays fairly stable because the time decay will erode away the option’s premium thus giving him an increasing opportunity to close out his position at a lower price or even holding the position till expiration, both resulting in a profitable trade.

On Volatility and Trend in option and stock trading. In general, it is better for individual trader to focus on the trend of the underlying (especially on breakouts) rather than the volatility, which will be more valuable to the institutions.

Dividend and Ownership. One of the main differences between option and stock trading is that by owning stocks, it means you have part ownership of the company and that you are entitled to the dividend payout. Owning option, however, does not entitle the option owner to dividend and also no ownership of the company.

Final verdict? You will have to draw your own conclusion on which instrument is best for you when comparing the pros and cons of option and stock trading, after knowing and understanding the characteristics of each and the differences between the option and stock trading. Comprehension of the risk and knowing how to manage it will be your primary concern before you can take steps to becoming a more and more successful trader.

Good Discipline = Good Luck!

Option and Stock Trading - An Explanation on Option Trading

Stock Option Basics - Basic knowledge on Stock Option Trading

Please Read Disclaimer