The best way to understand the characteristics of options vs stocks is to define what makes an equity investment like a stock have worth and then compare and contrast that equity concept with what makes an options contract have worth.
When you purchase the stock of a corporation you’re buying a tiny equity stake in that corporation. The size of your stake in proportion to the total equity available for purchase (the number of stock shares outstanding) governs how much you’ll pay for each share. If there are millions of shares available, the purchase of 1, 100, or even 10,000 shares doesn’t buy you much equity but it is real ownership of a tangible asset. Accumulate enough shares and you’ll eventually assume a large enough stake in the company to earn a say in how it operates and who gets elected to the board of directors.
With stock ownership, profit is made in a variety of ways. If the stock issues dividends you’re entitled to a share of those dividends in proportion to the number of shares you own. Sell a stock at a higher price than what you bought it for and you profit, sell it for less and you have a loss. You can trade a stock to other investors because a stock is an asset, a tangible ownership in a company. This same equity characteristic also lets you use stocks as collateral for loans and gives you the right to hold them until you decide to sell whether that be a few hours, a few months, or a few decades in your retirement account.
A stock is a real asset that can be bought, sold, used as collateral, and owned for as long as you see fit (or as long as the underlying company stays in business or remains publicly traded).
But, with options vs stocks, even though options are based on stocks they’re very different financial instruments.
An option isn’t part ownership in anything. It has no tangible value that can be used as collateral or that represents partial say in the future of a company. It doesn’t pay dividends and your holding period is limited to the expiration date of the options contract which is typically no more than a few months. You’re not likely to see options investments in your employer’s 401k plan and, unlike stocks, basing your retirement on a portfolio of options contracts isn’t such a good idea.
While a stock can rise or fall due to market conditions and underlying changes in the company the stock represents, the value of an option is only guaranteed to go down. The longer you hold it the less it will be worth until it, at expiration, it’s worthless. A stock will only become worthless if its company goes out of business and, even then, stockholders are likely to get at least a portion of their equity back during bankruptcy. Not so with an option.
Given these characteristics, you might wonder why anyone chooses options vs stocks but they do offer many compelling features that equity investments like stocks do not. For more on those features, see the article on understanding options.
