The Difference between an Option and a Stock

Understanding the differences between an option and a stock can be critical to making prudent investment decisions. The performance of these two instruments may have a direct correlation to capital commitment levels. In all cases, the differences are an important factor in determining the most sound investment approach.

Relative Price Movements

The price of an option may be directly or indirectly related to the price of the underlying stock upon which the option is written. While the specifics of the price relationships will differ based on various factors, in general, calls will rise in value as the price of the underlying stock increases and fall as the price of the underlying stock decreases.

The Capital Commitment

Options are derivatives, and thus trade primarily on margin – it requires less capital to “control” a similarly-sized option position than stock position. Recall that every option contract refers to 100 shares of the underlying security. Usually, the dollar amount of the profit on the stock is higher, but as a percentage of the capital outlay, it is higher on the option. Essentially, because of the leverage involved, you will realize a larger percentage gain or loss by owning an option.

Ownership Rights

The biggest difference between owning an option and owning the stock is in terms of the ownership interest. A stockholder owns equity in the company and is, therefore, an owner. An option holder has no ownership interest in the company and does not receive any rights.

A stockholder has the right to vote on matters of company governance, attend the shareholders’ meeting, and receive dividends. None of these rights are extended to option holders. This is reasonable given the fact that while a stockholder does not buy stock, in most cases, directly from the company, at some point every share was issued by the company and the company was paid.

With an option, the counter-party is unlikely to be associated with the company, and the company will receive no direct benefit from the existence and trading of the option contract. Finally, while a stockholder’s ownership interest in the company persists until he or she decides to sell the shares, an option contract will expire and terminate the holder’s interest.

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