Flexibility of Stock Options
Option holders have the right to choose whether to exercise the option before it expires or to abandon the option, instead of having to make a decision at the time of purchase. If an investor buys a call option, predicting that a company’s stock will rise in the next six months, and the stock has risen sharply after only three months, the investor can exercise the option early and lock in the profit. This choice reduces trading pressure for investors and allows them to take advantage of market volatility for greater returns.
From a data perspective, this flexibility of stock options makes them more attractive. According to OptionMetrics data, over the past decade, option holders in the U.S. stock market have had an average return of about 12% in a rising market, while stockholders’ returns over the same period were about 9%. Flexible exercise strategies help investors maximize profits while effectively mitigating potential market risks.
The Use of Leverage
Stock options offer significant leverage, meaning that investors can control more shares with less capital. For example, if a company’s stock price is $100, buying 100 shares requires a payment of $10,000, but by purchasing options on the same number of shares, the investor may only need to pay a $1,000 premium. In this case, the investor’s capital efficiency is greatly increased, and potential returns are higher.
Between 2019 and 2021, the S&P 500 index rose by about 40%, while the leverage effect in option trading allowed option investors to achieve an average return of 80%. This mechanism, which allows for higher returns with less capital, is very attractive to investors with limited funds. However, the leverage effect of options also carries higher risks, especially when the stock price does not rise as expected. In such cases, the investor may lose the entire option premium. According to CBOE data, about 80% of options expire worthless, and the investor loses the entire premium.
Risk Management Advantages
Stock options provide investors with a variety of risk management strategies, one of the most common being hedging through put options. Suppose an investor holds a batch of stocks and is concerned about a short-term price drop. They can purchase a put option to set a minimum sale price, thus limiting potential losses. An investor holding 100 shares worth $10,000 may pay $200 for a put option to protect themselves against a loss of more than 5%.
According to CFA Institute data, investors who use options for risk management can reduce their portfolio volatility by about 25%. Additionally, the transparency and liquidity of the options market allow investors to adjust their strategies flexibly based on different market conditions.
Long-Term Growth Potential of Stocks
Although stock options offer flexible short-term profit opportunities, from a long-term investment perspective, stocks may be more advantageous. Stock investors own a portion of the company and can benefit from both price appreciation and dividends. The S&P 500 index typically offers an annual dividend yield of about 2%-3%, and combined with long-term price appreciation, stockholders see higher compounded returns.
According to Morningstar data, from 1926 to 2021, the S&P 500 index had an average annual return of about 10%, with dividends accounting for about 40% of the return. In contrast, the returns from options mainly depend on short-term price fluctuations, and options do not generate dividend income. Furthermore, the expiration date limits the long-term growth potential of options.
Comparison of Trading Complexity
Option trading is significantly more complex than stock trading. The pricing of options is influenced by various factors, including the underlying stock price, volatility, time remaining, and interest rates. Investors need to understand the “Greek letters” — such as Delta, Gamma, Vega, and Theta — to evaluate changes in option prices. This makes options trading more suitable for experienced investors.
