Difference Between Stock and Option
The key difference between stock and option is that stock represent the shares held by the person in one or more than one companies in the market indicating the ownership of a person in those companies without the expiration date, whereas, the options are the trading instrument which represents the choice with the investor for buying or selling an underlying asset on the basis of option type to be executed before the expiry date.
Stock as an investment product is to invest in the shares of a company directly through buying the stock of that particular company. Thus, it represents part ownership in a corporation and entitles you to part of that corporation’s earnings and assets. Corporations issue stock, usually in two varieties: Common stocks and Preferred stocks.
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- Common Stocks: The Common stock is entitled to its proportionate share of a company’s profits or losses. The stockholders elect the Board of Directors. This board decides whether to retain or send some or all of those profits back to stockholders as dividends.
- Preferred Stocks: These stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares.read more receive a specific dividend at predetermined times. This dividend ordinarily has to be paid first, before the common stock dividends. If the company goes bankrupt, the preferred stockholders outrank the common stockholders in terms of potentially recouping their investment.
A stock option, on the other hand, is a privilege/option, sold by one party to another. It gives the buyer the right, but not the obligation, to buy or sell a stock (exercise the option) at an agreed-upon price (strike priceStrike PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market.read more) within a certain period (expiration date). Options are typical of two types: Call options and Put OptionsPut OptionsPut Option is a financial instrument that gives the buyer the right to sell the option anytime before the date of contract expiration at a pre-specified price called strike price. It protects the underlying asset from any downfall of the underlying asset anticipated.read more.
- An option is considered a call when a buyer enters into a contract to purchase a stock at a specific price by a specific date.
- An option is considered a put when the option buyer takes out a contract to sell a stock at an agreed-on price on or before a specific date.
Stock vs. Option Infographics
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Key Differences
- It is similar to 2 persons betting against each other on future stock value. The person who speculates that the price of the stock will go down would sell call stock Options (known as writing option) to the other person (option holder) who speculates that the price of the stock is going to go up.
- It allows the buyer to buy the stock at a fixed price, no matter how much the value of the stock appreciates during actual purchase. Then either sell the call options on to another buyer at a higher price or exercise the right vested in the call options to buy the stock from the seller at the lower agreed price. Thus buyer benefits from the appreciation through the option but does not own the stock yet.
- Also, Stock options are used as a risk management tool where they act as insurance policies against a drop in stock prices. At the cost of the option’s premium, the investor has insured themselves against losses below the strike price. This type of option practice is also known as hedgingHedgingHedging is a type of investment that works like insurance and protects you from any financial losses. Hedging is achieved by taking the opposing position in the market.read more.
Comparative Table
| Comparision | Stock Purchase | Stock Option |
| Ownership | Stock Purchase represents ownership in the company.
| The stock options represent the choice to buy or sell (depending on option type) a stock. |
| Dividend/Voting rights | Shareholder receives voting rights in important company matters and a share of the dividends (if any) paid by the company. | Stock option holders received no dividend and also did not enjoys voting rights. |
| Expiry | The stock of a company does expire until the company exists. In this aspect, the stock is an asset. | Options expire at a date in the future called the expiration date, after which point the investor no longer has the choice to buy or sell. In this aspect, the option is an expense if they expire out of money (loss). |
| Valuation | Stock Prices are based primarily on market forces, company fundamentals such as the company’s earnings outlook, the success of products, etc. | Stock option prices are based to a large degree on the price of the underlying stock, time to expiration, and other factors.
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| Trading/Investment | Stock is an investment instrument that can be sold to another investor at any point in time. | The option is a trading instrument and cannot be traded past the expiration date. |
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Risk
| Possible to lose the entire principal invested, and sometimes more. | As the holder of an option, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise. |
Conclusion
- The stock purchase is a traditional investment product where the investor invests in a company shares and expect returns in the form of dividend and capital appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.read more.
- On the other hand, options are a modern-day derivative product where the traders gain/loss based on the movement of a stock price value in the future time by paying a small premium amount to the writer of option instead of investing the amount equal to share value.
- So to conclude, they are both important portfolio tools for an investor where stocks are good for long-term investment purposes, and options are best who enjoy the flexibility and reduce the risk by hedging.
Stock vs. Option Video
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