Penny Stocks vs. Options | What Should You Trade?
Options and trading penny stocks are two different ways to trade high risk and high reward opportunities. Most new traders begin their journey with these two assets because of the high potential profit, but what they fail to realize is how different trading penny stocks and options really are.
The fact is that these two assets really don't share much in common at all! While the profit potential is high so is the risk which means traders need to be fully educated before deciding whether to trade penny stocks or options. Making the right choice could give traders a perfect start in their day trading careers. So let's dive right into the key differences and similarities between penny stocks and options.
What are Penny stocks?
The term penny stock typically refers to stocks that have a price under a dollar. Most of these stocks only cost pennies hence the name penny stock. The Securities and Exchange Commission defines the max value of trade penny stock as around $5, which means it is not uncommon to find these best stocks trading between $1 to $5.
Penny stocks may be hard to trade on certain brokerages because the major exchanges, for example New York stock exchange will not allow these stocks if certain criteria are not met. For example, the minimum stock price for stock to be allowed on the NYSE exchange is $1. The NYSE will remove stocks that fail to stay above $1 for 30 consecutive days. These stocks will become candidates for delisting or removal from NYSE trading. The rules set in place for the larger exchanges are meant to protect investors from these dangerous otc penny stocks losing value or being manipulated.
However, most penny stocks are often bought or sold on the over-the-counter market (OTC) as well as what is known as the pink sheets. The OTC market typically has less regulation which means much riskier stocks. While the risk is high some traders believe they are still worth trading and will have to do so in looser exchanges and stock markets.
Day trading penny stocks can be highly profitable. It may include the over the counter market's smallest companies, including newly established companies. These new companies can move large amounts from one penny stock news article, one contracts from a buyer, partnerships, buyouts, and more.
Pros and cons of penny stocks
Now we have a general understanding of buying penny stocks and what they are, let's break down the major advantages and disadvantages you need to be aware of as a new trader.
High Potential Returns
Penny stocks typically have a very low amount of shares available, a low market cap, and low prices. The low markets cap of these stocks just means that one partnership can increase the value instantly by a large amount. For example, if one stock received a partnership with Amazon, that would allow its sales to double and theoretically its price moves and doubles.
According to stock market news, most penny stock traders only trade big news releases. Once the news of his partnership is announced there will likely be a frenzy of buying and because of the low amount of shares available the stock could have no ceiling.
As you can see in the example below, many penny stocks moved 50-150% today. This volatility is a true treasure to traders that understand how to handle it.
One huge reason traders are attracted to penny stocks is how cheap they are. Someone with a $500 account, they're able to buy sometimes thousands of shares of these companies. With that same $500 account that trader would have hard time trading options of more established companies like Facebook and Netflix which trade over $200. Penny stocks allow new traders with small accounts the ability to not have to use their whole account and multiple stocks to buy.
High Liquid Events
When important news articles are released this produces an influx of buyers which means a lot of liquidity. The main problem in trading, in general, is making sure you have a tight spread between the buyers and sellers of the stock or option. Without a tight spread, the trader will constantly lose all your money getting in and out. So when trading these press releases for penny stocks there is typically a very tight spread when this happens. The trader should be careful that once the news settles and the buyers and sellers disappear, the spread can become quite wide again and make it hard to exit or enter.
Getting In Early
Penny stocks usually belong to new start-ups or small businesses. a company can grow exponentially with time, rewarding those who own stocks. Most traders never think to use penny stocks this way because of how risky they are and how rare it can be to find a great company. The fact is most early companies are very hard to invest in because they are in the private stock market where you need to have $1,000,000 to even have access to these companies. Few penny stocks allow traders to become investors and get in the very beginning with these new companies. If the stock takes off the rewards can be astronomical.
Free to Trade
Over the last couple of years, most brokerages have made stock trading totally free of trading fees. Free trading is a huge bonus for penny stock traders as commissions don't have to cut into profits. Traders will small accounts can really be harmed with high commissions and now have the ability to maximize returns without commissions.
Penny stocks are risky. They can lose value quickly. If we scan through the trade penny stocks that lost the most value a handful are down over 40% today. This means that traders can lose money sometimes within minutes or hours. Penny stocks have a very low amount of shares available which means if everyone is buying the shares the underlying stock could go up very quickly but if everyone is selling these shares can drop just as quickly. If there isn't a good past performance of buyers the stock will not be supported much on these sell-offs.
High Fraud, Scam, and Manipulation
They are not linked to well-known major exchanges. Hence, they are more prone to scams and fraud. Many cheap stocks are created by the companies attempting to make a quick profit, but actually, they do not have any value. The high fraud rate stops many traders from investing in these companies long-term. These stocks tend to not care about most investors in the slightest, this is where the phrase pump and dump came from. These companies are well known for hyping up a lot of news around the company while the owners and employees of the company are selling their stock on these pumps. This allows the insiders to profit while the investors buying the news are getting taken advantage of. Unfortunately, this is quite common.
As we talked about earlier, there are moments of very high liquidy but for the most part these stocks consistently have low liquidity. The liquidity is usually related to the amount of news and hype surrounding the stock. Most traders will tend to buy into the hype and then hold the stock even after the hype is gone and when the stock starts dying. This leads the traders to be caught in a stock when the liquid runs dry making it very hard to exit.
Hard to Short
One major disadvantage of investing in trade penny stocks is the fact that traders need to be using a margin account to short the stock. This means most traders can only buy penny stocks and make money from only then increase in value. Since we know in the long term most of these stocks won't survive, this makes it quite dangerous not being able to play the other direction.
For those traders who are playing the other direction, they will have to use margin which means in order to short the stock you have to borrow it from your broker. In order to close a short position, you have to buy back. Unfortunately, the volatility with penny stocks is so high that a trader can lose their whole account and more if the trade penny stock continues to run higher and higher. Shorting best penny stocks puts traders at a huge risk have a margin call in losing everything.
Penny stocks can increase in value very quickly due to sudden stock market news articles. The problem is if a trader misses the news article and ends up hearing about it too late they can end up getting into the trade at the wrong time losing lots of money. So the key to profitable penny stock trading is to have a great news scanner and alert system so the execution can be flawless. When it comes to find penny stocks trading time is money. This means traders are gonna have to monitor the news, their systems, and the trade constantly in order to do well with this.
How to get penny stock alerts instantly?
Time is money so knowing about a penny stock move the moment it happens is crucial to succeeding as a trader. There are many tools out there that can make this seamless and aid penny stock traders in this effort including Benzgina Pro.
As you can see in the picture below the signals tab allows traders to know a quick move happening in a stock. These alerts come almost every single second. A trader has the ability to set the highest possible price for these stocks which means we can target only penny stocks. Benzgina Pro also allows traders to get important SEC filings and news releases every single minute.
What are the options?
Options are contracts between two parties offering the rights to holders to purchase or sell any underlying assets like stocks in the stock market at a fixed price within a specific amount of time.
The value of the option is connected to the assets, which are bonds, interest rate, stocks, market indices, currency, exchange trade finds, and future contracts.
Option novice investors usually hold strong opinions on the future results or expected price of the stock in the future. However, options trading always has two sides: a seller and a buyer.
Sellers are also known as writers, and they must buy or sell the underlying security if the buyer has agreed to proceed with the option. On the other hand, buyers also have the right, but he is not obligated to sell or buy security against their will.
Pros and cons of options
Here are some advantages and disadvantages of the options. Even professional traders should know the potential and drawbacks of a successful trade.
High Potential Profit
Options can offer significant profit in a short period of time. The leverage associated with an option allows a successful trader receive potentially $100 for every $1 move in a stock. The closer and closer a trader gets to the expiration date the more volatile options tend to become.
As you can see in the example below these options are about to expire in 24 hours and moved 150 to 200% in one single day. These are very similar returns that can be found in penny stocks and that is why options are so attractive to new traders.
Some options are incredibly liquid while some options expire soon. There are many factors associated with option liquidity including the expiration date, the stock, the percentage out of the money, and more. The good news is there are many stock options that are highly liquid every single day. Unlike penny stocks which go through the highly liquid and low liquid moments, options have the ability to sustain liquidy for traders.
Playing Both Ends
The main advantage of options trading is the ability to play a bearish or bullish setup. The trader does not need to go on margin to do this but can simply buy calls or puts. This agility is what makes options trading so exciting.
Options have the ability to generate income from already existing portfolios. Options tend to decay every single day which is a bad thing for option buyers. Luckily there are some strategies out there where option sellers can profit from this daily decay. These strategies are lower risk and lower return but offer traders more consistency and profitability long term.
Assignment and Exercising
There is one huge concern with options which is assignment and exercising those options. Traders that are not aware have these two possibilities can end up with a large margin call. As stated earlier options give the buyer the ability to buy 100 shares of the stock which means the seller has to come up with 100 shares of this stock. Has the option buyer you have the choice to buy those 100 shares so be very careful you do not commit to buying their shares unless you want to. As an option seller, you have no choice when you're asked to come up with those 100 shares. Option sellers have a higher chance of entering a margin call because of this.
Costly to Trade
Unfortunately, most brokerages do not allow for free options trading. Most option trades can cost traders upwards of $5 to enter and exit. These costs can really add up over time and crush yearly returns, especially with a very small brokerage account. The brokerages that do offer free option traders tend to have many disadvantages that can harm traders in other ways.
Likely Going to Zero
Options have no fixed price, they can fluctuate a lot from day to day, and the cost can move up and down more than 50%. It implies that the investment can decrease in value quickly. Statistically, a large percentage of options are going to be totally worthless at the time of expiration which means options traders are fighting a huge uphill battle holding these trades every single day. This is a huge opportunity for option sellers if they understand how to utilize certain strategies.
How to Scan for Liquid Options
If you want to get started on your options trading journey but want to make sure you're looking at the right stock we are going to show you an easy way to scan for highly liquid options.
One of the most popular option scanners can be found on Barchart. As you can see in the example below the trader has the ability to change the options volume and open interest. Setting these to high or very high will produce scan results with the most traded options. These options tend to have the tightest spreads which means the least amount of money lost during entry and exit.
Difference: Penny stocks vs. Options
As we have seen a bunch of similarities, it is time to explore differences. Day trading penny stocks are pretty opposite to the small-cap stocks as well as options.
Potential upside: surprisingly enough options and best penny stocks have very similar upsides. Some days we can see hundreds of percentages for many different penny stocks and many different options. So if you're wondering which one can give the best possible profits these two trading assets are pretty equal.
Risk: surprisingly enough options in penny stocks have very similar risks. Options in general have a high chance of going to zero by the time of expiration. While it is rare for a penny stock to go to zero as quickly as options, the chance of a penny stock becoming extremely valuable in the long term is very small.
Brokerage services and commission: this is where we start to see the first difference. For most brokerages, you can trade money trading stocks totally for free. For most brokerages, you will have to pay to trade options somewhere around $0.65 a contract. These costs can really add up over time, especially for new traders with small accounts.
Playing both sides: options allow traders the ability to play I stock up and down the penny stocks can make this extremely difficult as it requires a margin account. This is why options are preferred over actual buy penny stocks.
Liquidity: while there are many penny stocks and options that lack liquidity a trader has the ability to screen and scan for stock liquidity that meets their criteria. Penny stocks will have a hard time sustaining high liquidity long-term because it is usually driven by news and hype. While options have the ability to have consistently high liquidity because large institutions are constantly trading popular indexes and stocks. If traders are not looking at these similar indexes and stocks they may have a hard time finding highly liquid options.
What do we prefer? Penny stock or option?
While the trader will have to make the decision at the end of the day whether penny stocks or options are right for them we want to give you our favorite choice based on all the information inside this blog. While penny stocks offer a huge upside potential we do believe the risks associated with these stocks are too high. The fact that a trader can only play the downside of these stocks with margin and higher volume, the fact that most of these companies rarely survive, the lack of liquidity, the need to constantly be monitoring and chasing the news, and more.
With all that being said, options are our go-to choice when it comes to trading volume with high-profit potential setups. Options allowed traders consistent liquidity every single day, consistent high-profit potential, the ability to take advantage of time decay, the ability to play both sides of the stock, and more portly the ability to trade without margin which can be very risky for new traders.
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