Indian financial markets provide a wide range of financial instruments for investors and traders to build their wealth as well as protect their capital. Among these financial instruments, options and stocks are very popular among market participants. Options and stocks are completely different financial instruments, and as an investor, it is important for you to have a basic understanding of these two financial instruments.

What is a stock?

If you plan to invest your money, there are many options for an investor. Among them, stocks are one of the most popular ways to invest. Stocks are not only used for investing but also traded for short periods. When you buy a stock or shares of a company, you become a shareholder of the company, which means you become a part owner of the company. You can own a stock through the primary market or the secondary market.

Primary market means you can buy a stock through initial public offering (IPO). Secondary market means you can buy and sell through the exchanges. There are two exchanges in India and they are called National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). If you buy a stock, you can hold the stock forever as long as the company is in operation and the company does not go back to being a private company.

Every share has a price and this price rises or falls based on a lot of parameters like earnings, positive and negative news, rumours, micro and macroeconomic factors, corporate governance, etc.

What are Options?

Options are financial instruments or derivative contracts that are mostly used by traders for trading or for hedging purposes to reduce risks. Options derive their value from an underlying asset. These underlying assets can be stocks or shares, indices like Nifty and Sensex, agricultural commodities, metals like gold, silver, etc., crude oil, natural gas, interest rates, etc.

In an options contract, there is a buyer and a seller. The options buyer is also known as the options holder, while the options seller is also known as the options underwriter. The buyer has the right, and not the obligation, to buy or sell the underlying asset at a specific price in the future at a particular date as per the options contract.

When an options buyer exercises his/her choice to buy or sell the underlying asset, the seller must oblige and cannot default. This is why the option seller has to pay a hefty margin to get into a contract and the option buyer must pay a premium to the seller. This premium is the price of the options contract and it is impacted by intrinsic value and time value.

The margin paid by the seller is like a collateral to cover potential losses and also meet the seller’s obligation. These losses can be huge for the seller if the seller takes a wrong trade, but for an option buyer the losses are limited to the premium paid.

When you buy an options contract, you cannot hold it forever as the options contract will expire after a certain number of days, weeks or months based on the contract. An options buyer does not become a part owner of the company. Between the two financial instruments, options are more risky than stocks as the potential for losses is a lot more. This has also been acknowledged by the market regulator, SEBI, in its report in 2023. The losses are high because options are leveraged financial instruments, i.e., a trader can take a big position with a small amount of capital which is not the case when buying a stock. This leverage amplifies the losses and increases the risks by multifold times.

How to invest or trade in stocks or options?

You can easily invest or trade by opening a free demat account with Aetram Trades India. To open a free demat account instantly, click the link. The account opening process is 100% digital, completely free and takes only a few minutes.

Conclusion

If you are a long-term investor, buying the shares of good quality companies is a good choice to grow your wealth as those shares may witness capital appreciation. Moreover, holding stocks of various companies is beneficial because the investor may receive dividends periodically and this is not the case when you buy options contract.

It is also important to asses if you are a trader or an investor and also evaluate your risk tolerance before you start trading or investing in stock or trading in options.

Frequently Asked Questions

1. Which financial instrument is best between stock and options for beginner long-term investor?

For long-term investment, it is best to invest in quality stocks as these have the possibility to compound over a long period of time. Options contract expire after certain days, weeks or months and it is not suitable for investments. Options are used for trading or hedging your stock holding and minimising your risks.

2. Are options suitable for beginners?

Options are complex financial instruments and it is better to trade options after gaining some experience in the stocks market.

3. In which exchanges options are traded?

NSE, BSE and MCX are three exchanges in India where options are traded. In MCX, you can trade in commodities related futures and options. In NSE and BSE, you can can trade in index and stock futures and options.

4. Which gives you dividend — options or stocks?

An investor holding a stock has the eligibility to receive dividends from companies which announce dividend payments through exchange filing. It is not necessary for all listed companies to pay dividends. It is the prerogative of the company to pay or not to pay dividends. If you are buying options or holding an options contract, you will not receive any dividends and there is no scope for dividends.

5. Which is riskier — options or stocks?

Options are riskier than stocks as options are more complex financial instruments compared to stocks. They are volatile and prices fluctuate drastically and the price depends on a lot of parameters including timing. Options will expire after a certain time where you can hold a stock forever till the company delists.