Stocks vs. Single Options vs. Option Spreads: What’s the Difference?

Do you know the difference between trading stocks, single options, and option spreads? The risk and return parameters between the three can be drastically different and it is important to understand the differences for your investment strategy. Let’s work though an example together, comparing the three investment methods performance using a 2% increase in the hypothetical stock, ABC, which has a current stock price of \$100. For this example, we’re going to ignore trading
fees and commissions.

Example 1: 10 shares of stock
A 2% increase in ABC from 100 to 102 would increase the value of 10 shares of stock from \$1,000 to \$1,020, a gain of \$20. Remember, to hold this position in a cash account, the holder of the shares would need to buy \$1,000 of ABC stock upfront.

Example 2: 1 ABC \$101 single call option
Let’s assume that this call option costs \$1.00 to put on and that we were at the expiration date. With the stock price gaining 2\$ to get to \$102, this call option would still be worth \$1 (\$102 stock price – \$101 strike price), leaving the holder of the call to breakeven. Not much excitement here, even though the stock price did in fact go up!.

Example 3: 1 ABC \$101 / \$102 call spread
For this spread, we assume that we are using same call as above (\$101 call that costs \$1.00) and a \$102 call that we can sell for \$0.50, forming our \$101 / \$102 spread that we can put on for \$0.50. At expiration, this position is worth \$0.50, representing a 100% gain on our initial position. With the same move, the call spread has a significantly higher gain (\$50) and a much lower entry cost.

Here’s a snapshot of the returns of the hypothetical trade:
·       Example 1 (stock): 2% gain on \$1,000 entry cost (\$20 absolute gain)
·       Example 2 (single call): breakeven = no gain or loss on \$100 entry cost
·       Example 3 (call spread): 100% gain on \$50 entry cost (\$50 absolute gain)

Real-world examples may yield different results due to market pricing, but in
general these relationships will hold when comparing the three methods of trading.

Key takeaways: Stock trading costs the most and yields smaller percentage moves; single calls or puts are more expensive than spreads and have a higher breakeven (but also have the most upside); and option spreads have the lowest cost and lowest breakeven price.

While all three methods of trading can be appropriate depending on strategy and goals, it’s important to know the general differences and similarities! At Optionality, we feature a pre-packaged menu of option spreads, offering a ‘walled-garden’ approach to the trading experience. Highlighting the entry cost, max gain, and breakeven price for every trade, before execution. Check us out on the Appstore or Google Playstore!

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