The study of choices can help you see that there are more options than you thought. Equity and debt are the two types of investments that most people know about. There is, however, a third way, which is much more interesting than the first two. It has qualities that most people don't understand. These differences can be seen as a set of troublesome problems or as a set of exciting opportunities.
Let's start by taking a quick look back at the two most common ways to invest. When you make an equity investment, you buy a piece of a company. The best-known example of this is buying stock in a company that is open to the public and whose shares are sold on stock exchanges. Each share of stock shows how much of the company's total capital, or ownership, that person has.
When you buy 100 shares of stock, you have full control over your money. You decide how long to keep the shares and when to sell them. Stocks give you real value because they let you own a piece of the company. If you own stock, you can get dividends if they are paid out and vote in elections if they are open to stockholders. (Some special stocks that don't have voting rights don't have this right.) If the price of the stock goes up, you will make money. You can keep the stock for many years, or even your whole life, if you want to. Stocks can be bought and sold on public exchanges or used as collateral to borrow money because they have real value.
Example
In exchange for cash, you buy 100 shares at $27 each. This costs you $2,700, plus any trading fees. You get a message telling you that the purchase has been made. This is an investment in equity, and you are a stockholder in the company.
The second type is a debt investment, which is also known as a debt instrument. This is a loan from the investor to the company, government, or government agency. The company, government, or government agency agrees in a contract to pay back the loan plus interest. Bonds are the most well-known type of debt instrument. Bond issues are how corporations, cities, and states, as well as the federal government, its agencies, and subdivisions, pay for their operations and projects. Investors in bonds are not stockholders; they are lenders. When you own a bond, you also own something you can touch, which is not stock but a legal right with the lender. The person who gives you the bond promises to pay you interest and give you back the money you lent by a certain date. Bonds can be used to borrow money, just like stocks. They also go up and down in value based on how much interest they pay compared to how much interest is being paid on the market right now. As part of their contract, bondholders are usually paid back before stockholders if the company that issued the bonds goes bankrupt. This is one way that bonds are better than stocks.
Example
Lending Your Money: You give the U.S. government $9,700 to buy a bond that is currently worth $9,700. Even though you invest your money in the same way that stockholders do, you are now a bondholder, which doesn't give you any equity. You lend money and have a debt instrument.
Less people know about the third way to invest. Both equity and debt have a real value that we can see and touch. Equity and debt investments are based on the fact that the investor gets a share of a company or has a legal right to get paid back. Not only are these things real, but they also have an end date. Stock ownership lasts as long as you own the stock and can't be taken away unless the company goes out of business. A bond, on the other hand, has a repayment schedule and an end date that are written into the contract. The third type of investment doesn't have any of these things, and it's over in a short amount of time. You might be hesitant to put money into a product that disappears and stops being worth anything. In fact, it has no real worth at all.
So we're talking about putting money into something that doesn't have any real value and will be completely worthless in a few months. To make things even more confusing, imagine that the value of this intangible will definitely go down as time goes on. To make things even more confusing, imagine that these features can be both good and bad, depending on how you use the products.
These are some of the things that options have to offer. If you look at these things on their own (and out of context), they don't make this market look very appealing. Options seem too risky to most people because they don't have any real value, aren't worth much in the short term, and are losing value. But for you, there are good reasons. Not all ways to invest in options are as risky as they might seem. In fact, some of them are quite safe because the things we just talked about can work in your favour. No matter how you use options, the fact that there are so many ways to use them makes them one of the more interesting ways for investors to make money. The more you learn about options, the more you realise that they are flexible, that they can be used in many situations and to create many opportunities, and, most interestingly, that they can be very risky or very safe.
Tip
Strategies for options range from being very risky to being very safe. On one end of the spectrum, risk can hurt you, but on the other, it can help you. Options give you a lot of different choices.
