There are numerous advantages and disadvantages with options and you’re being very thorough by asking. Despite the vast number of ways we could address this question, let’s start by understanding the most fundamental difference between stocks and options.
The biggest difference between stocks and options is that options expire while stocks do not. Because of this, the price you pay for an option slowly decays with the passage of time. It is this little nuance that creates many advantages and disadvantages for the options trader.
For example, assume a stock is trading for $100 and you buy a $100 call for $3. At expiration, the stock is trading for $105. With the stock at $105 at expiration, the $100 call is worth $5 thus providing a $2 return on a $3 investment (66%) for the option trader. The stock trader makes $5 on the trade for a 5% return.
So one advantage is that the option provides much bigger leverage for the trader. The same $5 move in the stock presents a 66% return to the option trader while only 5% to the stock trader. On the other hand, the stock trader earned the full $5 move of the stock while the option trader only gained $2. The missing $3 was the time premium he paid for the option. The time premium is something you never get back, which is an apparent disadvantage. I say it is “apparent” because it depends on how you look at it. The option trader also only had $3 at risk; that’s the most he could lose. The stock trader could lose much more than that. Even though the option never regains its time premium (disadvantage) that same time premium limits the losses to the option trader (advantage).
For those stock traders who do not like the idea of time decay this does not mean that options are of no use. Instead, these traders can sell options and collect the time premium in exchange for assuming an obligation. One of the most common strategies is the covered call where the investor sells calls against stock that he’s already holding in the account. By selling a call, the investor has the potential obligation to sell shares of stock for the strike price over a given time period. In exchange for accepting that obligation, the covered call seller collects the time premium of the option thus providing income as the option decays.
Whether an option is good or bad strictly depends on what you’re trying to accomplish. But you can be sure that any argument for or against options will somehow involve the fact that an option’s price decays over time. The best thing to do is to continue learning about options to see how they can best be used for your goals.
You may wish to take the free online course Exploring the World of Options under our "classes => free classes" tab as it will give you much better insights into what options are all about and how they can be used to hedge market risk.