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Stocks and Options: Similarities and Differences

Many investors ask about the fundamentals of options and the difference between types of options. Here I share some background on the fundamentals of option trading. Bonus: An active option trade is shown below for our Covered Call of the Week.

There are both similarities and differences between stocks and options. Some think of options as a stock substitute which is correct in some cases. However, it is important to know the differences as you include both in your investing plan.

Similarities:

  • Stocks and options are both securities. Options are technically derivatives since they relate to another security: shares of stock.
  • Stocks are traded on exchanges and also over-the-counter. Stock options trade only on exchanges regulated by the SEC.
  • Market makers buy and sell stock options as they do stocks.

Differences:

  • Stock represent an equity ownership interest in the company. An option is a contract.
  • Options expire on their respective expiration dates. An option not exercised by its expiration date expires worthless. Stocks never expire except when a company goes out of business.
  • Stocks are represented by stock certificates, although buyers often don’t see the shares because they are held in the broker’s street name. But options are maintained in the form of electronic book entry only, and there are no certificates that represent options.
  • At any time, there is a fixed number of shares of stock outstanding. However, there is no limit to the number of option contracts that can be created on a stock.
  • Holders of stock have the right to vote and receive dividends, but holders of options have neither, since the option is only a contract to buy or sell.

COVERED CALL TRADE OF THE WEEK

KKR & Co. (KKR)

The KKR Oct 25, 2019 covered call with a $27.50 strike price (selling at $0.85) could potentially yield a 3.89% return if KKR stays above $27.50 a share at expiration 26 days from now. The covered call has a 3 Key (Moderate Relative Risk) ranking. On 07/26/19, Argus Research set a $31.00 12-Month price target for KKR, which is currently trading at $3.68 below that target. By using this covered call strategy potential returns may be higher than simply holding the stock if KKR stays below $28.38 through Oct 25, 2019. The covered call strategy offers limited protection if the stock drops in price, but if the stock goes below $26.47 expect losses.

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