If you are thinking of investing in listed options, you need to appraise how they compare with the rest of the other financial instruments. So it is not enough to only learn what options contracts are and how they operate, but it helps to learn a bit about the other investments.
Herein we will compare options to the following instruments:
Comparisons Between Stocks and Options
Investing in stocks represents shares of ownership of a corporation. You can buy and sell these shares individually. Options have two essential characteristics: First, the price of an option is not the price of the stock it represents. The price depends on the riskiness of the option.
Second, an option is a contract. You do not buy the option; you buy the right to sell. An option is not an asset; it is a contract. When you have an option, it implies you are owed nothing, and you can do nothing.
People who buy shares tend to think about them as tangible objects, as things they must own. On the other hand, people who buy options regard them as intangible rights, as things they can trade.
An advantage of buying options over stocks is that you can limit potential losses while benefitting from potential profits. Options trading limits potential losses which you may incur if you buy stocks.
Comparisons Between Futures and Options
Options and futures have similarities that pose a lot of confusion. Both are leverage derivatives and offer leverage and hedging benefits. However, the difference lies in the obligations of the parties to the contracts. The holder of an option has a right to buy option at a fixed price.
A futures contract obligates both parties to fulfill contract terms at the point of expiration and, in essence, exposes both buyer and seller to unlimited risks. As such, futures contract carries more risks than options contract; hence options are more advantageous than futures.
Comparisons Between Forex and Options
The most significant advantage of trading options is the flexibility to trade options contracts in various underlying securities such as stocks, commodities, and futures. However, Forex is limited to foreign currencies only and predicting their price movements requires detailed analysis.
Another advantage with options trading is the presence of a degree of risk control whereby you can limit risk by using various strategies. With options, you can leverage and hedge as well.
Comparisons Between Bonds and Options
Bonds appeal to conservative investors who are risk-averse and prefer straightforward investment vehicles. Both options have similarities regarding the parties to the contracts, except that the governments usually issue bonds.
Options contracts give buyers the right to buy or sell an option at a specific price on or before a certain date. A bond is a loan that is used to finance significant transactions. The contract for a bond is such that everyone knows how much has to be returned and when.
The advantage is that options offer potentially big profits with less investment, unlike bonds where you invest significant amounts of money in realizing meaningful returns. Furthermore, you may trade options at any adverse circumstance given the use of various strategies to apply.
Comparisons Between Warrants and Options
Trading in warrants allows you to capitalize on increases in share prices without actually having the shares. It is an investment strategy that can be very profitable, but it comes with risks. A warrant is a contract between the buyer and the seller.
The buyer receives an option to buy shares at a specified price within a specific predetermined timeframe. The seller’s offer entitles the buyer to purchase the stock within an allotted time for a fixed price predetermined by the warrant upon purchase.
You can trade in the money calls or puts, which means you can profit if the price moves in your favor. One advantage of trading in options is that you can create spreads, use leverage and offer accessibility and versatility to traders.
When investors want to leverage their portfolio holdings, they usually need to use some derivative product. For example, bonds, stocks, Forex, warrants, and options are investment vehicles that can help diversify your portfolio in different ways and have various risks and rewards associated with them.