Options vs. stocks: Which is right for you?

When taking stock of how to invest in the market, you have options — both literally and figuratively.

While there are important differences between stocks and options — and the type of investors who gravitate to each — these assets can complement one another in your portfolio.

But when you need to choose between stocks and options, the guidelines below can help you make the right choice.

Stocks: Best for beginners, long-term investors

If you are looking for a straightforward way to begin investing for a goal more than five years away, such as retirement, stocks are a great choice. While there's no guarantee you will make money — the performance of any individual stock can be volatile — the U.S. stock market has proved to be a fantastic long-term investment.

For beginner investors, and especially people with a long-term strategy, stocks are a clear winner over options, said Aaron Anderson, senior vice president of research at Fisher Investments. That's because in addition to lower expenses and a more straightforward approach, stocks allow for a hands-off investing style.

After researching the stocks you wish to invest in — ones that you believe have a growth potential that fits your time horizon — you don't need to obsessively check on them every day. You can simply keep an eye on them until the time comes when you need that money or set an alert through your online broker when the stock's price reaches a level at which you want to sell.

Potential drawbacks: Risk, fees, taxes

The risk associated with stocks is straightforward: The price could plummet. Because the performance of individual stocks can be volatile day to day, experts generally recommend investing in stocks with money you won't need for at least five years. To further reduce risk, don't pile all your money into a single stock.

How active a trader you are will affect performance — and how much you'll pay in commission fees and capital gains tax on profits. Commission fees for stock trading vary, so shop around before opening an account. Your capital gains tax rate depends on whether you realize a profit on the sale of the stock, how long you have held it — rates are higher for stock held less than a year — and your income.

Options: Best for active traders

Looking for a more tactical approach to investing, one with a smaller investment requirement and flexibility regarding timing or downside risks? Options may be up your alley.

With options, the associated time period for investment is inherently shorter, making them more appealing to traders who buy and sell regularly. Options contracts have expiration dates, which range from days to years.

While many people like the flexibility afforded by options, they do add complexity to the investing process. Rather than making one decision, such as betting that a stock's price will go up, you must make three:

What direction the stock is headed; how high or low it will move from its current price; and, the time frame in which that will happen.

Options trading requires you to learn a new vocabulary of terms like puts, calls and strike prices, which may lead you to believe these assets are riskier than stocks. That notion is overstated, especially because investors can let an option expire and incur no further financial obligation other than the premium paid and associated trading costs, said Wade Guenther, a portfolio manager at Horizons ETFs Management. What's more, long-term investors can use options as a type of insurance, he adds.

Potential drawbacks: Effort, additional risks, cost

Options trading requires a more hands-on approach than investing in stocks. You may wish to exercise the option before expiration, and that means you will have to keep a watchful eye on the related stock's price.

Also, some options strategies are riskier than others, so make sure you understand the trade in advance.

Another downside is the related costs, which generally are higher than for stocks. Options traders usually pay a flat fee per trade, ranging from zero to $6.95 at the major brokers, plus a per-contract fee ranging from 15 cents to 75 cents. The more you trade, the higher your costs. Finally, as with stocks, be sure to factor in capital gains taxes.

Making your choice

Beginner investors and those who prefer simplicity generally should stick to stocks for their straightforward nature. Those who favor an active approach and love to watch the market may find options appealing.

But don't assume you have to stick to one asset. Options traders inherently become stock investors if they exercise call options. And many stock traders use put options as a hedging mechanism. Whatever you decide, make sure you understand what you're doing.

Anna-Louise Jackson is a writer at NerdWallet. E-mail: ajackson@nerdwallet.com. Twitter: @aljax7.