Are you looking to begin trading in the stock market? The key word here is “begin.” When most new traders are beginning to trade, they don’t have massive amounts of money to work with. Because of this, they quickly realize they don’t have the account size to be able to trade big board stocks like Apple and Netflix.
Due to this, many traders embark on a quest to find something that can help with their situation. After going through search engines and other forms of internet searching, many times they are drawn into penny stocks due to the promises of large account expansion with little money required. It would not shock me at all if you’ve already taken a look at penny stocks, as they have a much lower cost of entry and can offer those promised “off the charts” gains.
My real question to you is this: have you taken a look at options? Maybe you aren’t sure what the difference is? Below, we'll cover the differences between penny stocks and options so you can make the best decision for your personal trade plan and goals. The comparison will be broken down into nine different sections, and in each section, we'll address penny stocks and options.
When trading both penny stocks and options, assuming you have a top discount broker, the fees are virtually the same, so the cost of trading is a wash. Sure, some brokers are better than others for penny stocks just like some brokers are better than others for options, but all in all, if you find the right broker for what you are wanting to trade, it's an even matchup. When it comes to regulations, there also isn't an edge when it comes trading to one or the other. Both are restricted by the pattern day trader rule that limits you to only three “day-trades” a week if your account is under $25k.
Number of Trading Opportunities
What do I mean when I say “opportunities”? Simply put, this means the frequency in which a viable trade situation comes around where you could really make money. In the penny stock world, a given stock can go months at a time with very little or no movement. It can sometimes be really hard to actually find a penny stock that is moving and is setting up for a trade.
Why is this the case? By nature, the penny stock market is very illiquid, meaning there just isn’t much trader activity. Traders must buy and sell among one another to create volume (liquidity), and there just is not large consistent amount with penny stocks. Options, on the other hand, are based on big board stocks and ETF’s. With these types of stocks and ETFs, there is a consistent and routine high amount of volume each and every day, making it much easier to find an opportunity that gives you a realistic chance to pull profits from the market.
Potential Trade Gains
The allure of both penny stocks and options is the low cost of entry and high percentage gains, so if all else was created equal, this would be a tie. For the numerous downfalls of penny stocks, to be fair, penny stocks, if they can get moving, can certainly make large jumps in price due to high volatility. Keeping things in perspective though, when we bring opportunities (see above discussion) into the equation we see that options have the ability to allow for these types of gains much more frequently.
Cost to “Get Involved” in the Trade
As mentioned a couple of times already, both penny stocks and options have a fairly low barrier to entry. Meaning the cost to start trading is quite low. In both cases, $1,000 or maybe even less would be more than enough to get started.
Your Trade Plan Is at the Mercy Of ...
In the trading world, you want to be able to put yourself in situations with as many variables remaining unchanged as possible. When it comes to penny stocks this can be hard. Often times the management is a very flaky and does not act in the company’s best interest. You are really at their mercy as they could make some bone-headed announcement or decision that causes a large drop in the price and therefore destroys the position you are holding and leave you flailing in the wind.
Options, on the other hand, are based on big board stocks. These are large companies that have tried and true records and are run by highly intelligent management teams and board of directors. In other words, there is rarely any drama with a big board company. You can count on these companies being run well and won’t have the violent swings in management. With penny stocks, “drama” is a commonly used (and rightfully so) word to describe them.
How Fluid Is Trading (Volume)?
Fluidity is a big issue when it comes to penny stocks. Many times, if you pull up a penny stock technical chart, the price is jumping all over the place and the chart as a whole appears “choppy.” This is due to the small and inconsistent amount of volume of shares being traded. This creates the problem of unreliable technical indicators, chart patterns, and a host of other tools that traders attempt to use.
Options, being based on big board stocks, have much higher volume. The best way to illustrate this is to tell you to go and pull up a penny stock and a big board stock, both looking at the 5-minute timescale. You’ll see that the big board stock has a much more fluid trading pattern. The penny stock chart will be very choppy looking and may not even look like much of a chart at all. By being more fluid, decision making and reliability with options makes it much easier to identify patterns and trends in the chart.
How Easily Can You Sell?
There are two parts of a successful trade, buying and selling. This may seem very obvious, but it is the part that most new traders do not understand. Remember, you can always “buy.” But in order to “sell,” there has to be someone who wants to buy from you. This is getting repetitive I know, but I hope you are seeing the massive problem of volume.
Because in penny stocks there is not a huge amount of volume, at times it can be VERY difficult to find a buyer for your penny stock shares when you want to sell, especially if you put in larger amounts of money. With options and their higher volume, there is almost always someone out there looking to buy. In other words, using an economics term, it is a very efficient market. (Read more about when to sell stocks.)
Making Money Flexibility
How many different strategies can you run? With penny stocks, you are limited to just going long in the stock. Technically, you can short penny stocks, but finding the right brokers is an annoying quest at best. On top of this, the fees associated with shorting penny stocks (due to the HIGH risk involved) are extremely high.
The point is that you can only make money within penny stocks when the stock price goes up. Options allow for 100% flexibility. Whether the price goes up or down, the way options are structured still gives you the opportunity to profit. To spice things up that much more, with some of the more advanced options strategies, you can even make a profit if the price of the stock sits still and does nothing.
As any seasoned trader who has been around will tell you, every stock has a personality. If you follow one stock long enough you can begin to learn and identify with that personality (defined as “how the stock tends to move”) and use that to your advantage.
With penny stocks, this is hard and essentially impossible. In the vast majority of instances, the stock “in play” is good for a few days/week and maybe a couple months before it drifts into oblivion. Because penny stocks that are “in play” are constantly changing, this cycle makes it nearly impossible to identify the personality of any given stock. With options, there are many stocks that day in and day out are consistent with activity. Therefore, it allows traders to learn “how” the stock price tends to move.
Our score is thus 6 to 3 – in favor of options. Does that mean you shouldn’t trade penny stocks? Absolutely not. If penny stocks fit better into your strategy and plan, then go that route. But often, people who started out trading penny stocks eventually move to options for many of the reasons listed above (and talking with these people is how I’ve constructed this list). Penny stock traders eventually get sick of tired of “watching paint dry” as they wait for their positions to move. Others simply become frustrated because while sure, they can buy shares, when it comes time to sell those shares (for either a profit or a loss), it can turn into much more than just a click of the “sell button.”
All in all, you need to put as many odds in your favor as possible, and the reality of the situation is that options trading allows you much more freedom, opportunity, and flexibility.