investing

The Difference Between Options & Stocks

Justin McCormick

VP of Operations & Finance, WealthFit

You’re interested in investing, but you’re not sure where to start. You’ve heard promising things about both stocks AND options—but which is right for you?

When you do invest, you don’t want to do it blindly. You want to know strategies. You want to have information that will make you an investor, not just somebody with investments.

Look no further. It’s time to discuss the wonderful world of stocks and options, and the many ways you can utilize them to achieve your financial goals.

What are Stocks?

A stock is a piece of ownership in a company that is listed on an exchange. These pieces of ownership are often called shares. When you buy shares of a company, you become a shareholder. Each company has a certain amount of shares in the stock market that individuals are able to buy and sell on the stock exchange in real time.

It is up to the company how many shares can be bought. The company can either increase or decrease the number of shares in the exchange. The company will use stock splits to create more shares or reversal splits to diminish the number of shares. This is risky business. The company must do this with price and demand in mind. If not, there could be some big issues.

When it comes down to it, trading stocks is all about supply and demand. Supply and demand are constantly evolving and adapting, meaning buyers and sellers of a company’s stock need to keep up.

Stock Ownership

Each stock you purchase allows you ownership over a certain percent of the company whose shares you hold. This does not mean that your shares in stock allow you control over branches of the company. Rather, you get a say in company matters and a return on your investment based on how the company performs.

To determine what percentage of the company you own: divide the amount of stock you own in that company by the total amount of shares the company is floating in the stock market.

Here’s an example:

Applied Materials, Inc. (AMAT) currently has 973.58 million shares floating in the stock exchange. Let’s say you own 340.753 million shares of AMAT. To determine what percentage of the company you own, simply divide the amount you own (340.753 million) by 973.58 million. You’ll get an answer around 35 percent. That’s a lot of shares and it makes you an important owner in the company.

As a shareholder, this means you can attend major meetings. You also have the opportunity to vote on company decisions that will impact its future, like mergers with other companies or selecting members for its board of directors.

Typically, shareholders only hold a small percentage of the company. However, people who control a majority of the shares—majority shareholders—are able to make larger decisions for the company.  The more shares you own, the louder your voice is.

Why Stocks Are More Valuable As Long Term Investments and Not in the Short Term

In the short term, stocks are driven by emotion and hype. Investors get excited and want to invest in businesses that are launching new and exciting products. On the other hand, investors will pull away from a stock when bad deals or shady practices are unearthed.

However, studying the company’s financials and overall fundamentals can give a dedicated investor an edge on determining a company's future earnings, valuation, and stock price. If you choose a long-term investing strategy, then you’ll most likely become a value investor. This means you’ll need to weigh the potential risks and rewards of stocks before you buy.  

Let’s look at our AMAT example once again:

At $38.65 per share, AMAT is trading way below value. Their targeted average price is typically $60.62 per share. This indicates that AMAT is 63.7% undervalued.

Your average investor might be turned off by this price drop. But value investors, like Warren Buffett, might be even more interested. They may decide to study this company’s financials. Here, one of two things can happen:

  1. If they find that it is a healthy and profitable company with good management, they can reasonably expect the market to correct itself. Until then, they have the opportunity to buy shares for nearly half the targeted average price.
  2. If they find that there are major flaws in the company contributing to its stock market demise, they can rest easy knowing that their money isn’t invested in AMAT and wait for the next potential investment.

Dividends can add extra value to stocks the longer you hold onto them. Dividends are sums of money (or shares) paid by a company to its shareholders out of the company’s profits. If the dividends are reinvested into more shares of stock, the interest on them will continue to grow and add more value to your shares in the long term. This is something Warren Buffett does to increase the value of his investments.

Reinvested dividends include your yields, which create more dividends and more yields. It’s a cycle that repeats itself over and over, growing and fortifying your portfolio.

Going Long and Short with a Stock

When purchasing stocks, you’re making a bet. Maybe you’re betting that a stock price is going up, or long. You could also bet that it’s going to go down, or short. This is important to differentiate, as going long and going short have very different processes.

When going long with a stock, your goal is to hold onto that stock with no expectation of selling it in the near future. You’re typically using the money from your own bank account to purchase your shares. You can also use leveraged loans or credit cards to purchase additional shares at a certain interest rate.

Going short with shares of stock is different. You don’t use your own money. Instead, you borrow shares from a broker dealer at a specific price level. The goal here is not to hold onto these shares and wait for them to accumulate value. Rather, you want to sell the shares and buy them back at lower price rates, then return them to the broker after making a profit.

But this is risky. If the stock goes up rather than down, the broker might ask for their shares back. When this happens, you lose money.

You can choose to go long or short with a stock, depending on your style and what interests you. But be warned—going short with stocks is more popular among wealthy investors via hedge funds. They can afford to make risky bets and lose money. If you can’t, going long might be your best move.

What are Options?

Options are an asset class that belongs to a group of securities known as derivatives.

Let’s look at what that means.

A derivative is an asset with a price that’s dependant on the price of an underlying investment—like a stock or a bond. In this case, the value of the option will be based on the value of an underlying stock.

When buying an option, it is important that you consider a few things:

The strike price

The strike price is one of the most crucial pieces of the puzzle when buying an option. A strike price is the price you can buy or sell underlying stock for. More on that later.

The expiration date

Unlike stocks, you can’t hold onto your options forever. Options contracts can last one, two, three, six, or twelve months. They can also range from one to three years, depending on the person holding it. The longer you are able to hold onto your option, the longer you have to do something with it.

The premium

When entering into an options contract, you pay a fee for the option called a premium. Premiums are priced per share, and their prices will change based on changes in market prices.

Options contracts are typically made up of 100 shares of underlying stock, meaning that you are paying a premium for 100 shares of stock.

Call Options vs. Put Options Contracts

Basically, an option gives you the right to buy or sell shares of a stock at a certain “strike price” by the option’s expiration date. Whether you can buy or sell the underlying shares depends on what type of option you buy.

Call Options

Call options give whoever holds them the power to buy shares of a stock at a set price, also known as the strike price. If you buy a call option, you are expecting the underlying stock to experience an increase in price. That way you can use your option to buy the stock at the lower “strike price” even though it’s worth more.

Here’s our AMAT example once again, but with options:

At the moment, share prices are closed at $38.34. You think the prices will increase, so you want to buy a call. Any “strike price” under $38.34 will be “in the money,” meaning you’re on track to make a profit if the stock increases in price before your option reaches its expiration date.

You buy an option for AMAT with a strike price of $37 and an expiration date of January 2019. When the expiration date rolls around, shares are worth $53. Whoever sold you the option is still obligated to sell you those shares of stock for $37. This gives you an opportunity to turn a profit by selling those shares now, or holding onto them and hoping their value increases even more.

Again: the key to call options is to purchase them with low strike prices and the expectation that the stock price will go up by the expiration date.

Put Options

Put options are the opposite of call options. With puts, you are expecting that the underlying stock is going to decrease in price. This way you will be able to sell the stock at a higher “strike price” back to the person who sold you the option by its expiration date, even though the shares are now worth less.

You do not need to own the underlying stock to use puts, but it’s a smart way to protect your investments.

Now back to AMAT.

You own shares of AMAT and you think their price is going to drop by January 2019. At the moment, share prices are closed at $38.34. You want to purchase a put option above the current price. You buy an option with a strike price of $40 and an expiration date of January 2019. If AMAT’s stock tanks and shares are suddenly worth $20, whoever sold you the option is obligated to buy your shares at $40 a piece rather than their actual lower value.

This way, you can protect your investment.

Reasons for Holding vs. Trading Options

Puts and calls can be considered insurance or hedging strategies for positions in your stock portfolio, as you’re betting on future prices in a certain time period. This is a strategy that is more conservative and long-term.

However, options do not need to be held until their expiration date—they can be traded at any point to other interested parties. These transactions are typically based on current market prices and changes in premium rates.

This approach is known as “selling covered calls” and it is one of the main financial strategies that Warren Buffett and other wealthy investors use to create their empires.

Some people focus on making money by constantly trading these options while some people may just enter the deal in the long term selling stock they own at set prices while earning money from the premium.

Options vs. Stocks and the Law of Attraction

When comparing stock and option strategies, it’s important to remember that stocks and options are closely linked with each other. Options are based on the prices of underlying stocks. Options and stocks can be held for the same company. When considering options vs. stocks, it’s also important to remember that they’re both related via the same corporate entity that issued the shares in the first place.

To choose between a stock and an option, you’ll need to know yourself and your financial situation fairly well. Ask yourself some of these questions:

What is your risk tolerance?

Are you a long-term investor or a short-term investor?

Where will you get more bang for your buck?

In the end, it will be up to you to determine what investment opportunities are right for you.

Share

Written By

Justin McCormick

Justin is the VP of Operations & Finance. He has leveraged his passion for education, entrepreneurship, and numbers into a versatile portfolio of investments which include stocks, real estate, oil & gas, green energy, real estate lending, online and offline startups, restaurants, and more.

Read more about Justin

RELATED TRAINING

 in 

INVESTING

podcast
6X ROI, Skin in the Game, & When To Get Out

Serial entrepreneur Justin McCormick on the lessons learned from building 3 successful tech companies and becoming an investor.

6X ROI, Skin in the Game, & When To Get Out

Listen Now
article
How Much Money Do You Really Need To Start Investing in Real Estate?

How much money do you really need to start investing in real estate? It's probably less than you think! Learn how to do the math.

How Much Money Do You Really Need To Start Investing in Real Estate?

Justin McCormick

Read Now
article
How To Invest In Real Estate With Bad (or no!) Credit: Learn 5 Different Methods

Bad credit is an obstacle to real estate investing, but not a big one. Learn 5 ways to invest in real estate with bad credit.

How To Invest In Real Estate With Bad (or no!) Credit: Learn 5 Different Methods

Justin McCormick

Read Now
article
What's the Difference Between Naked Options & Covered Options?

What are the differences between naked and covered options? If you're an investor, you need to know how to use either (or both) correctly.

What's the Difference Between Naked Options & Covered Options?

Justin McCormick

Read Now
article
Real Estate Investing: A Step-by-Step Path to Early Retirement

How much passive income do you need per month to retire and live the life of your dreams? Learn how real estate investing can get you there fast.

Real Estate Investing: A Step-by-Step Path to Early Retirement

Justin McCormick

Read Now
article
7 Real Estate Investing Shortcuts: How to Get Started with Less Upfront Cash

Any cash you put in a real estate investment is cash you can’t use elsewhere. Here are 7 ideas to get that upfront cash as low as possible.

7 Real Estate Investing Shortcuts: How to Get Started with Less Upfront Cash

Justin McCormick

Read Now
article
How to Find the Best Real Estate Investment Deals On The Block

All real estate investors begin by finding the best deals on the block. Use these strategies to find the deals others don’t see.

How to Find the Best Real Estate Investment Deals On The Block

Justin McCormick

Read Now
podcast
A Radio Ad, The Rehab & Purposefully Networking

In this episode, Amy Mahjoory takes us through her journey from leaving corporate America and investing in Fortune Builders, to building her real estate empire. Learn firsthand how you too can Network with a Purpose, build a strong team, and turn a part-time real estate gig into a million dollar business.

A Radio Ad, The Rehab & Purposefully Networking

podcast
Almost Going Public, Investing In Horses & Culture

From restaurant investor to horse investor, Eric Berman is the "Millionaire Matchmaker" who pairs investments, brands and influencers with their ideal audience! Listen in as he and Dustin discuss the best ways to brand a business and teach you exactly how to stay on top of digital marketing trends.

Almost Going Public, Investing In Horses & Culture

podcast
Mobile Home Millions, Lifestyle Design & Taps

In this episode, Doug Ottersberg, business and life strategist and the co-author of The Serious Business Owner's Guide to Serious Business Success, sits down with Dustin Mathews to talk about financial success and shares his top tips for building wealth and breaking into the industry of mobile home investments.

Mobile Home Millions, Lifestyle Design & Taps

podcast
Rebounding From A Near Death Experience, Bankruptcy & The Crash

In this jam-packed episode, Dustin is joined by real estate investor and tech entrepreneur, Steve Jackson. Listen in and hear the "close calls" that finally led to the dream of having a portfolio of passive income-generating properties.

Rebounding From A Near Death Experience, Bankruptcy & The Crash

podcast
My Worst Investment Ever

In this thought provoking episode, Andrew Stotz takes us through his worst investment ever, and breaks down the six core ways people lose money. Grab a notebook and pen, because this episode is sure to transform the way you view investing and give you a deeper understanding of the stock market and how to build wealth.

My Worst Investment Ever

podcast
4 Interesting Takeaways from the Berkshire Hathaway Annual Meeting

Each year, the country’s top investing and money-minded individuals gather at the Berkshire Hathaway Annual Meeting. Get insight into this exclusive event with Dustin's major takeaways.

4 Interesting Takeaways from the Berkshire Hathaway Annual Meeting

article
The Simple Guide To REITs: How To Invest In Real Estate With Less Risk & Regular Returns

Thinking about investing in a Real Estate Investment Trust (REIT)? Learn what they are, how they work, and how to pick the best one for you.

The Simple Guide To REITs: How To Invest In Real Estate With Less Risk & Regular Returns

Abhi Golhar

Read Now
article
How To Take Investing Seriously & Stop Playing With Your Money

Don McDonald dispels the most common myths about investing and lays out a strategy for a balanced portfolio and consistent returns.

How To Take Investing Seriously & Stop Playing With Your Money

Don McDonald

Read Now
Creative Real Estate Investing Showcase

Creative Real Estate Investing Showcase

Behind-the-Scenes on 3 Unique Investment Deals

WealthFit Trainers

Watch Now
Private Lending Showcase

Private Lending Showcase

Behind-the-Scenes on 4 Successful Real Estate Loans

WealthFit Trainers

Watch Now
Real Estate Wholesale Showcase

Real Estate Wholesale Showcase

Behind-the-Scenes on 2 Successful Wholesale Deals

WealthFit Trainers

Watch Now
Real Estate Fix & Flip Showcase

Real Estate Fix & Flip Showcase

Behind-the-Scenes on 13 Successful Rehab Projects

WealthFit Trainers

Watch Now
Facebook Live Marketing

Facebook Live Marketing

How to Exponentially Increase Your Number of Leads Using Facebook Live

Bob McIntosh

Watch Now
podcast
Secrets of a "Financial Concierge"

Anything can happen in the world of finance. Travis Jennings teaches you to use the tools at your disposal to make (and keep) your fortune.

Secrets of a "Financial Concierge"

Online Lead Generation

Online Lead Generation

How to Find Great Investment Properties On The Internet

Ralph Plumb

Watch Now
Rental Properties 101

Rental Properties 101

How To Buy Your First Cash-flowing Rental (The Right Way)

Deslyn O’Dell

Watch Now
Wholesaling Legally

Wholesaling Legally

Simple Steps to Compliance as a Real Estate Wholesaler

Angela Gregg

Watch Now