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When people talk about buying stock, especially in the short term, very few people are aware of options trading, but they are pretty similar as they both entail trying to make a profit. The fact that trading options can be based on various underlying securities means plenty of variables when deciding how and where to invest.
But do they always trade in batches of 100 shares?
In most cases, the size for an options trade is almost always 100 shares. In rare cases, it could be different because of a stock split or options contracts sold outside of the USA.
When you buy or sell a call or put contract in the USA they will always be for 100 shares of the stock or ETF. However if the underlying stock has a stock split or reverse stock split then that contract might only be worth 10 shares of the stock after the split.
Your brokerage will have a notification on any option that you own if it has been involved in a stock split explaining what the new value of the option contract is.
The rest of this article will explain a few related topics in detail, which will include why people engage in options trading, and how it differs from stock trading.
To read more about option trading as well as to learn different strategies just click here.
Why Have A Standard Option Contract?
A standard for trading options means that you avoid possible trading complications and detailed accounting of trades. Since 100 shares equal one contract, it reduces the use of large numbers in trading options.
Some countries tend to have other lot sizes, such as 10 in India, or 1000 in Australia, but this usually comes with certain caveats, such as paying more for them per share when compared to the standard 100 lot sizes.
The Reasons That People Engage in Trading Options
Despite the intricacies of trading options, modern investors tend to trade options as opposed to other financial instruments, some of which include the following:
Less Capital Is Required
Capital plays a significant role in whatever business venture one decides to engage in. If a lot of money is required, the tendency for people to venture into it becomes low.
In comparison to stock trading, the capital needed to buy a unit of stock might be able to purchase a 10-100x the number of options contracts, if 100 shares equal one contract.
If trading is done with the correct information and discipline, it could yield far greater returns when compared to stock trading.
With the correct information, options trading involves fewer risks than stock trading because it involves a lower financial commitment than buying equities. Due to the amount of capital required, the investor is willing to take the risk and also forgo the investment if the trade does not turn out as planned.
Options provide leverage as they offer the same price movements as a share of the underlying stock while generally costing much less.
For example, a stock like Apple, which is currently trading at around $242.50, would cost $24,250 to buy 100 shares. However, it only costs $630 (or $6.30 per share in premium) to buy a $242.50 call option, which expires in 15 days.
Higher Potential Returns
Options offer potential higher returns to investors compared to buying shares of a stock.
So if you spend less money and you make almost the same profit as trading stock, you will have a higher percentage return.
Considering this scenario, compare percentage returns of a stock purchased for $100 and option purchased at $12 at a delta of 80. If the stock were to go up by $10, your stock would provide a 10% return instead of the 80% gained on options.
Options Contracts Provide Insurance To Investors
To avoid certain asset-related risks, options investors may adopt insurance plans. There are times when crashes occur in the stock market, so how does an investor remain protected?
Through options contracts, investors have a significant level of downside coverage for adverse risks.
Time Required To Realize Profits
The time required to realize profits when trading options contracts is shorter when compared to other financial instruments. The downside of this is that timing is critical in options trading.
If the stock doesn’t move in the direction you think it will within the exact time of the contract, you can be out a great deal of money (potentially the entire premium paid for the call/put).
Options Vs. Stock Trading
Those who trade both options and stocks have a goal to generate profit on selling or buying stocks, or contracts, but there are specific characteristics peculiar to them.
Let’s talk about some of these options now.
When you buy shares of a stock in a particular company, you are purchasing a share in that company. The way options work is different.
When you buy stock options, you buy a contract that gives you the right to buy or sell specific stocks at an agreed upon price (the strike price). With options you don’t actually own anything but the contract.
Options contracts will have a specific time frame to be executed. As soon as that time frame expires without meeting the strike price, the trade is declared worthless.
Stocks are valuable for as long as the company is still in operation (or until they declare bankruptcy which makes the stock worthless). Although a stock’s value may depreciate or appreciate from time to time you could theoretically own stock in a company forever.
In this way, stocks are deemed assets.
The price of shares of stock is based primarily on market forces, the success of products, and the company’s earnings. In contrast, the price of options contracts depends on the cost of the underlying stock, the time to expiration as well as how volatile the stock price typically is.
Owing stock grants the investor voting rights in essential company matters and also a share of the dividends that may be issued. Since the stock is not owned under options contracts, the investor is not granted voting rights or any form of dividends.
The complexity of options trading is much higher than stock investing and options are better suited to a skilled investor, unlike stock trading that is beginner-friendly and pretty easy for most investors.
Mastering options trading takes a good deal of time and effort and until you have done your research, you should keep your option trades modest or stay away from options altogether.
In a scenario where an investor does not have sufficient information regarding a stock but is optimistic about it, the investor could decide against buying the actual stock and choose to purchase an options contract.
This way, if the stock price does not go as planned, the investor loses only the smaller premium paid for the options contract as opposed to losing more capital that was paid for purchasing actual shares.
This is known as risk management.
In most cases, the lot sizes for options contracts are usually 100 shares, except in some areas where there are avenues for special lot sizes, which typically come with certain caveats.