How can options make more money than stocks if they are both based on the same thing?

Question

How can options make more money than stocks if they are both based on the same thing?

In: Economics

Answer 1

Let’s say a stock trades at $50. You think it’ll be worth $60 in 2 months. You can buy shares for $50 and if it rises to $60 you’ve profited 20%.

Or you could buy an option to purchase shares at $55 2 months down the road. When the stock trades at $50, that might only cost you something like $2 a share (x100 shares). If the stock actually hits $60 then, you’d pay $55 for shares worth $60 and have an immediate 250% profit.

So with $200 you could buy 4 shares, make 20% and profit $40.

Or you could buy options on 100 shares, execute the option and immediately sell shares for $60 that cost $55 and profit $500. And if the stock shot up to $100, you’d turn your $200 into $4,500 (very rare, but basically what some WSB apes did on GameStop).

But the risk is that if the stock doesn’t move in the way you think, you could end up losing your whole $200, vs. the stock just going down in value but could bounce back if you hold longer term.