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Call options allow the option holder to purchase an asset at a specified price before or at a particular time. Put options are opposites of calls in that they allow the holder to sell an asset at a specified price before or at a particular time. The holder of a call speculates that the value of the underlying asset will move above the exercise price strike price before expiry.

Conversely, a holder of a put option speculates that the value of the underlying asset will move below the exercise price before expiry. Options are used to either provide investors with the means to speculate on both positive and negative market movements of securities or help manage the risk of adverse financial market conditions and potentially offset losses. Financial institutions such as banks provide online services that allow trading of standard option contracts stock options, commodity options, bond options, stock index options, options on future contracts etc in national exchange markets eg.

OTC options are primarily used as solutions to hedge risk of company specific risk scenarios. Typical OTC options include interest rate option, currency option, and options on swaps swaption. Interest rate options allow companies to set predetermined upper cap and lower floor limits on floating rates for a stated time period. Collars involve simultaneous purchase of a cap and sale of a floor by companies who are borrowing, or purchase of a floor and sale of a cap if they are protecting an investment.

In this way, they are able to benefit from any favourable movements in interest rates between the 'collar rates' cap and floor while being protected from any adverse movements outside those limits. Currency options are options added to FX forward contracts. At expiry of the option, users have the choice of exchanging or not exchanging currencies at the predetermined forward rate. The company seeks a low-cost solution to cover its consequent currency exposure and to protect its budget rate of 1.

It believes that sterling will depreciate but is prepared to forego some participation in the benefits in return for full protection of its budget rate. As the premium amounts are equal, the 'contract' is zero cost. At expiry, there are three possibilities:. Companies that regularly utilise options to manage risk tend to be large firms with large financial exposure to floating rates such as interest, FX and commodities.

The potential financial losses due to exposure amount will be the primary determinant of justifying the cost of using option derivatives to mitigate risk. Option premium is the price of an option charged by the writer or sold on an exchange market. Further transaction costs and capital gains taxes may be incurred. Prices can also vary depending on the relationship between buyer company and writer bank and average cost can be reduced by negotiating bundled services from banks.

Arrangements that involve combining both call and put options allow companies to set their own rates in line with their views on rate movements and to suit their financial strategies. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. An option is a contract that gives an investor the option to buy or sell a stock or other security — usually in bundles of — at a pre-negotiated price by a certain date.

An option is a type of derivative, because it derives its value from an underlying asset [0] Investor. Investor Bulletin: An Introduction to Options. Accessed Mar 8, View all sources. An options contract isn't an obligation to buy or sell the underlying security. You also have the option to let the contract expire, hence the name.

Options contracts exist for a variety of securities, but this article focuses primarily on options for stocks. In that context, there are two main types of options contracts:. Call options. Put options. Once you buy the contract, a few things can happen between the time you purchase it and the time of expiration.

You can:. Sell the contract to another investor. Let the contract expire and walk away with no further financial obligation. Investors use options for different reasons, but the main advantages are:. Buying an option means taking control of more shares than if you bought the stock outright with the same amount of money.

Options are a form of leverage, offering magnified returns. An option gives an investor time to see how things play out. An option protects investors from downside risk by locking in the price without the obligation to buy. You can lose your entire investment in a relatively short period [0] The Options Clearing Corporation.

Characteristics and Risks of Standardized Options. With certain types of options trades, it's possible to lose more than your initial investment. See our full options terms and definitions page for more information. In the money. At the money. Out of the money. A derivative is a type of financial product whose value depends on — is derived from — the performance of another financial instrument. Options are derivatives. Spreads are an advanced trading strategy in which an options trader buys and sells multiple contracts at different strike prices.

If the stock price rises above the strike price, the contract itself gains intrinsic value, and the price of the premium will rise accordingly. This means you could sell the contract to another investor before expiration for more than you bought it for, taking a profit. Put options serve a similar purpose as shorting a stock — both let you profit if the stock price falls.

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Funds investing in argentina | Part of. A less common usage of an option's delta is the current probability that it will expire in-the-money. For the employee incentive, see Employee stock option. Other options The flexibility of options allows them to be structured to the needs of the customer. Key Takeaways Options are financial derivatives that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date. |

Consolidation in forex | Options meaning in finance optionson the other hand, allow the holder to sell the asset at a stated price within a specific timeframe. A further, often ignored, risk in derivatives such as options is counterparty risk. If the prevailing market share price is at or below the strike price by expiry, the option expires worthlessly for the call buyer. How Options Work for Buyers and Sellers Options are financial derivatives that give the buyer the right to buy or options meaning in finance the underlying asset at a stated price within a specified period. If the stock price rises above the exercise price, the call will be exercised and the trader will get a fixed profit. Partner Links. The potential financial losses due to exposure amount will be the primary determinant of justifying the cost of using option derivatives to mitigate risk. |

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Remove unused variable Now it is and, by extension, a single application it in ssh, fix wrong image. Any chance that. I would say. Splashtop remote desktop to or need to take advantage and web filtering.A call option would normally be exercised only when the strike price is below the market value of the underlying asset, while a put option would normally be exercised only when the strike price is above the market value. When an option is exercised, the cost to the option holder is the strike price of the asset acquired plus the premium, if any, paid to the issuer.

In any case, the premium is income to the issuer, and normally a capital loss to the option holder. The holder of an option may on-sell the option to a third party in a secondary market , in either an over-the-counter transaction or on an options exchange , depending on the option. The market price of an American-style option normally closely follows that of the underlying stock being the difference between the market price of the stock and the strike price of the option. The actual market price of the option may vary depending on a number of factors, such as a significant option holder needing to sell the option due to the expiration date approaching and not having the financial resources to exercise the option, or a buyer in the market trying to amass a large option holding.

The ownership of an option does not generally entitle the holder to any rights associated with the underlying asset, such as voting rights or any income from the underlying asset, such as a dividend. Contracts similar to options have been used since ancient times. On a certain occasion, it was predicted that the season's olive harvest would be larger than usual, and during the off-season, he acquired the right to use a number of olive presses the following spring.

When spring came and the olive harvest was larger than expected, he exercised his options and then rented the presses out at a much higher price than he paid for his 'option'. The book Confusion of Confusions describes the trading of "opsies" on the Amsterdam stock exchange, explaining that "there will be only limited risks to you, while the gain may surpass all your imaginings and hopes.

In London, puts and "refusals" calls first became well-known trading instruments in the s during the reign of William and Mary. Their exercise price was fixed at a rounded-off market price on the day or week that the option was bought, and the expiry date was generally three months after purchase. They were not traded in secondary markets. In the real estate market, call options have long been used to assemble large parcels of land from separate owners; e.

In the motion picture industry, film or theatrical producers often buy an option giving the right — but not the obligation — to dramatize a specific book or script. Lines of credit give the potential borrower the right — but not the obligation — to borrow within a specified time period.

Many choices, or embedded options, have traditionally been included in bond contracts. For example, many bonds are convertible into common stock at the buyer's option, or may be called bought back at specified prices at the issuer's option.

Mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option. Options contracts have been known for decades. The Chicago Board Options Exchange was established in , which set up a regime using standardized forms and terms and trade through a guaranteed clearing house. Trading activity and academic interest has increased since then. Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges , while other over-the-counter options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker.

Options are part of a larger class of financial instruments known as derivative products , or simply, derivatives. A financial option is a contract between two counterparties with the terms of the option specified in a term sheet. Option contracts may be quite complicated; however, at minimum, they usually contain the following specifications: [8]. Exchange-traded options also called "listed options" are a class of exchange-traded derivatives. Exchange-traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the Options Clearing Corporation OCC.

Since the contracts are standardized, accurate pricing models are often available. Exchange-traded options include: [9] [10]. Over-the-counter options OTC options, also called "dealer options" are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need.

In general, the option writer is a well-capitalized institution in order to prevent the credit risk. Option types commonly traded over the counter include:. By avoiding an exchange, users of OTC options can narrowly tailor the terms of the option contract to suit individual business requirements. In addition, OTC option transactions generally do not need to be advertised to the market and face little or no regulatory requirements.

However, OTC counterparties must establish credit lines with each other, and conform to each other's clearing and settlement procedures. With few exceptions, [11] there are no secondary markets for employee stock options. These must either be exercised by the original grantee or allowed to expire. The most common way to trade options is via standardized options contracts that are listed by various futures and options exchanges.

By publishing continuous, live markets for option prices, an exchange enables independent parties to engage in price discovery and execute transactions. As an intermediary to both sides of the transaction, the benefits the exchange provides to the transaction include:. These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hedging.

An option contract in US markets usually represents shares of the underlying security. A trader who expects a stock's price to increase can buy a call option to purchase the stock at a fixed price strike price at a later date, rather than purchase the stock outright. The cash outlay on the option is the premium.

The trader would have no obligation to buy the stock, but only has the right to do so on or before the expiration date. The risk of loss would be limited to the premium paid, unlike the possible loss had the stock been bought outright. The holder of an American-style call option can sell the option holding at any time until the expiration date, and would consider doing so when the stock's spot price is above the exercise price, especially if the holder expects the price of the option to drop.

By selling the option early in that situation, the trader can realise an immediate profit. Alternatively, the trader can exercise the option — for example, if there is no secondary market for the options — and then sell the stock, realising a profit. A trader would make a profit if the spot price of the shares rises by more than the premium. For example, if the exercise price is and premium paid is 10, then if the spot price of rises to only the transaction is break-even; an increase in stock price above produces a profit.

If the stock price at expiration is lower than the exercise price, the holder of the option at that time will let the call contract expire and lose only the premium or the price paid on transfer. A trader who expects a stock's price to decrease can buy a put option to sell the stock at a fixed price strike price at a later date.

The trader is under no obligation to sell the stock, but has the right to do so on or before the expiration date. If the stock price at expiration is below the exercise price by more than the premium paid, the trader makes a profit. If the stock price at expiration is above the exercise price, the trader lets the put contract expire, and loses only the premium paid.

In the transaction, the premium also plays a role as it enhances the break-even point. For example, if the exercise price is and the premium paid is 10, then a spot price between 90 and is not profitable. The trader makes a profit only if the spot price is below The trader exercising a put option on a stock does not need to own the underlying asset, because most stocks can be shorted. A trader who expects a stock's price to decrease can sell the stock short or instead sell, or "write", a call.

The trader selling a call has an obligation to sell the stock to the call buyer at a fixed price "strike price". If the seller does not own the stock when the option is exercised, they are obligated to purchase the stock in the market at the prevailing market price. If the stock price decreases, the seller of the call call writer makes a profit in the amount of the premium. If the stock price increases over the strike price by more than the amount of the premium, the seller loses money, with the potential loss being unlimited.

A trader who expects a stock's price to increase can buy the stock or instead sell, or "write", a put. The trader selling a put has an obligation to buy the stock from the put buyer at a fixed price "strike price". If the stock price at expiration is above the strike price, the seller of the put put writer makes a profit in the amount of the premium. If the stock price at expiration is below the strike price by more than the amount of the premium, the trader loses money, with the potential loss being up to the strike price minus the premium.

Combining any of the four basic kinds of option trades possibly with different exercise prices and maturities and the two basic kinds of stock trades long and short allows a variety of options strategies. Simple strategies usually combine only a few trades, while more complicated strategies can combine several. Strategies are often used to engineer a particular risk profile to movements in the underlying security. For example, buying a butterfly spread long one X1 call, short two X2 calls, and long one X3 call allows a trader to profit if the stock price on the expiration date is near the middle exercise price, X2, and does not expose the trader to a large loss.

A condor is a strategy that is similar to a butterfly spread, but with different strikes for the short options — offering a larger likelihood of profit but with a lower net credit compared to the butterfly spread. Selling a straddle selling both a put and a call at the same exercise price would give a trader a greater profit than a butterfly if the final stock price is near the exercise price, but might result in a large loss.

Similar to the straddle is the strangle which is also constructed by a call and a put, but whose strikes are different, reducing the net debit of the trade, but also reducing the risk of loss in the trade. One well-known strategy is the covered call , in which a trader buys a stock or holds a previously-purchased long stock position , and sells a call. This can be contrasted with a naked call.

See also naked put. If the stock price rises above the exercise price, the call will be exercised and the trader will get a fixed profit. If the stock price falls, the call will not be exercised, and any loss incurred to the trader will be partially offset by the premium received from selling the call.

Overall, the payoffs match the payoffs from selling a put. This relationship is known as put—call parity and offers insights for financial theory. Another very common strategy is the protective put , in which a trader buys a stock or holds a previously-purchased long stock position , and buys a put. This strategy acts as an insurance when investing on the underlying stock, hedging the investor's potential losses, but also shrinking an otherwise larger profit, if just purchasing the stock without the put.

The maximum profit of a protective put is theoretically unlimited as the strategy involves being long on the underlying stock. The maximum loss is limited to the purchase price of the underlying stock less the strike price of the put option and the premium paid. A protective put is also known as a married put. Another important class of options, particularly in the U.

Other types of options exist in many financial contracts, for example real estate options are often used to assemble large parcels of land, and prepayment options are usually included in mortgage loans. However, many of the valuation and risk management principles apply across all financial options. Because the values of option contracts depend on a number of different variables in addition to the value of the underlying asset, they are complex to value.

There are many pricing models in use, although all essentially incorporate the concepts of rational pricing i. The valuation itself combines a model of the behavior "process" of the underlying price with a mathematical method which returns the premium as a function of the assumed behavior. The models range from the prototypical Black—Scholes model for equities, [16] [ unreliable source? See Asset pricing for a listing of the various models here.

As above, the value of the option is estimated using a variety of quantitative techniques, all based on the principle of risk-neutral pricing, and using stochastic calculus in their solution. The most basic model is the Black—Scholes model. More sophisticated models are used to model the volatility smile. These models are implemented using a variety of numerical techniques. More advanced models can require additional factors, such as an estimate of how volatility changes over time and for various underlying price levels, or the dynamics of stochastic interest rates.

The following are some of the principal valuation techniques used in practice to evaluate option contracts. Following early work by Louis Bachelier and later work by Robert C. In options trading, when the put-call parity principle gets violated, traders will try to take advantage of the arbitrage opportunity. An arbitrage trader will go long on the undervalued portfolio and short the overvalued portfolio to make a risk-free profit. Let us now consider an example with some numbers to see how trade can take advantage of arbitrage opportunities.

In this case, the value of portfolio A will be,. Portfolio B is overvalued and hence an arbitrageur can earn by going long on portfolio A and short on portfolio B. The following steps can be followed to earn arbitrage profits. Return from the zero coupon bond after three months will be This stock will be used to cover the short. So far, we have gone through options trading basics and looked at an options trading strategy as well. Options are attractive instruments to trade in because of the higher returns.

This way, the holder can restrict his losses and multiply his returns. While it is true that one options contract is for shares, it is thus less risky to pay the premium and not risk the total amount which would have to be used if we had bought the shares instead. Thus your risk exposure is significantly reduced. However, in reality, options trading is very complex and that is because options pricing models are quite mathematical and complex.

So, how can you evaluate if the option is really worth buying? The key requirement in successful options trading strategies involves understanding and implementing options pricing models. In this section, we will get a brief understanding of Greeks in options which will help in creating and understanding the pricing models. For OTM call options, the stock price is below the strike price and for OTM put options; stock price is above the strike price.

It is based on the time to expiration. You can enroll for this free options trading strategies course on Quantra and understand options trading basics that will help you in options trading. We know what is intrinsic and the time value of an option. We even looked at the moneyness of an option. But how do we know that one option is better than the other, and how to measure the changes in option pricing.

Greeks are the risk measures associated with various positions in options trading. The common ones are delta, gamma, theta and vega. With the change in prices or volatility of the underlying stock, you need to know how your options pricing would be affected. Greeks in options help us understand how the various factors such as prices, time to expiry, volatility affect the options pricing.

Delta is dependent on underlying price, time to expiry and volatility. While the formula for calculating delta is on the basis of the Black-Scholes option pricing model, we can write it simply as,. Here, we should add that since an option derives its value from the underlying stock, the delta option value will be between 0 and 1. While the delta for a call option increases as the price increases, it is the inverse for a put option.

Think about it, as the stock price approaches the strike price, the value of the option would decrease. Thus, the delta put option is always ranging between -0 and 1. Gamma measures the exposure of the options delta to the movement of the underlying stock price. Hence, gamma is called the second-order derivative. Let's see an example of how delta changes with respect to Gamma.

In this way, delta and gamma of an option changes with the change in the stock price. We should note that Gamma is the highest for a stock call option when the delta of an option is at the money. Since a slight change in the underlying stock leads to a dramatic increase in the delta. Similarly, the gamma is low for options which are either out of the money or in the money as the delta of stock changes marginally with changes in the stock option. You can watch this video to understand it in more detail.

Theta measures the exposure of the options price to the passage of time. It measures the rate at which options price, especially in terms of the time value, changes or decreases as the time to expiry is approached. Vega measures the exposure of the option price to changes in the volatility of the underlying. Generally, options are more expensive for higher volatility. So, if the volatility goes up, the price of the option might go up to and vice-versa.

Vega increases or decreases with respect to the time to expiry? What do you think? You can confirm your answer by watching this video. One of the popular options pricing model is Black Scholes, which helps us to understand the options greeks of an option. To calculate the Greeks in options we use the Black-Scholes options pricing model. Delta and Gamma are calculated as:. In the example below, we have used the determinants of the BS model to compute the Greeks in options.

At an underlying price of If we were to increase the price of the underlying by Rs. As can be observed, the Delta of the call option in the first table was 0. Hence, given the definition of the delta, we can expect the price of the call option to increase approximately by this value when the price of the underlying increases by Rs.

The new price of the call option is If you observe the value of Gamma in both the tables, it is the same for both call and put options contracts since it has the same formula for both options types. If you are going long on the options, then you would prefer having a higher gamma and if you are short, then you would be looking for a low gamma. Thus, if an options trader is having a net-long options position then he will aim to maximize the gamma, whereas in case of a net-short position he will try to minimize the gamma value.

The third Greek, Theta has different formulas for both call and put options. These are given below:. In the first table on the LHS, there are 30 days remaining for the options contract to expire. We have a negative theta value of He has to be sure about his analysis in order to profit from trade as time decay will affect this position.

This impact of time decay is evident in the table on the RHS where the time left to expiry is now 21 days with other factors remaining the same. As a result, the value of the call option has fallen from If an options trader wants to profit from the time decay property, he can sell options instead of going long which will result in a positive theta.

We have just discussed how some of the individual Greeks in options impact option pricing. However, it is very essential to understand the combined behaviour of Greeks in an options position to truly profit from your options position. If you want to work on options greeks in Excel, you can refer to this blog. Let us now look at a Python package which is used to implement the Black Scholes Model.

Mibian is an options pricing Python library implementing the Black-Scholes along with a couple other models for European options on currencies and stocks. In the context of this article, we are going to look at the Black-Scholes part of this library. Mibian is compatible with python 2. This library requires scipy to work properly. The function which builds the Black-Scholes model in this library is the BS function. The syntax for this function is as follows:.

The first input is a list containing the underlying price, strike price, interest rate and days to expiration. This list has to be specified each time the function is being called. Next, we input the volatility, if we are interested in computing the price of options and the option greeks. The BS function will only contain two arguments. If we are interested in computing the implied volatility , we will not input the volatility but instead will input either the call price or the put price.

In case we are interested in computing the put-call parity, we will enter both the put price and call price after the list. The value returned would be:. The syntax for returning the various desired outputs are mentioned below along with the usage of the BS function. The syntax for BS function with the input as volatility along with the list storing underlying price, strike price, interest rate and days to expiration:. The syntax for BS function with the input as callPrice along with the list storing underlying price, strike price, interest rate and days to expiration:.

The syntax for BS function with the input as putPrice along with the list storing underlying price, strike price, interest rate and days to expiration:. The syntax for BS function with the inputs as callPrice and putPrice along with the list storing underlying price, strike price, interest rate and days to expiration:. While Black-Scholes is a relatively robust model, one of its shortcomings is its inability to predict the volatility smile.

We will learn more about this as we move to the next pricing model. The Derman Kani model was developed to overcome the long-standing issue with the Black Scholes model , which is the volatility smile. One of the underlying assumptions of Black Scholes model is that the underlying follows a random walk with constant volatility. However, on calculating the implied volatility for different strikes, it is seen that the volatility curve is not a constant straight line as we would expect, but instead has the shape of a smile.

This curve of implied volatility against the strike price is known as the volatility smile. If the Black Scholes model is correct, it would mean that the underlying follows a lognormal distribution and the implied volatility curve would have been flat, but a volatility smile indicates that traders are implicitly attributing a unique non-lognormal distribution to the underlying. This non-lognormal distribution can be attributed to the underlying following a modified random walk, in the sense that the volatility is not constant and changes with both stock price and time.

In order to correctly value the options, we would need to know the exact form of the modified random walk. More specifically a unique binomial tree is extracted from the smile corresponding to the random walk of the underlying, this tree is called the implied tree. This tree can be used to value other derivatives whose prices are not readily available from the market - for example, it can be used in standard but illiquid European options, American options, and exotic options.

Steven Heston provided a closed-form solution for the price of a European call option on an asset with stochastic volatility. This model was also developed to take into consideration the volatility smile, which could not be explained using the Black Scholes model.

The basic assumption of the Heston model is that volatility is a random variable. Therefore there are two random variables, one for the underlying and one for the volatility. Generally, when the variance of the underlying has been made stochastic, closed-form solutions will no longer exist. But this is a major advantage of the Heston model , that closed-form solutions do exist for European plain vanilla options. This feature also makes calibration of the model feasible.

If you are interested in learning about these models in more detail, you may go through the following research papers,. So far, you have understood options trading and how to analyse an option as well as the pricing models used. Now, to apply this knowledge, you will need access to the markets, and this is where the role of a broker comes in.

How does one go about options trading? By creating an account first. Here's how you need to go about it:. Once the required background research is done, you can choose the right broker as per your need and convenience. In the global market, a list of the top brokers is provided below:. The list of top Indian options brokers is given below:.

One of the most popular options trading strategies is based on Spreads and Butterflies. Spreads or rather spread trading is simultaneously buying and selling the same option class but with different expiration date and strike price. Spread options trading is used to limit the risk but on the other hand, it also limits the reward for the person who indulges in spread trading. Thus, if we are only interested in buying and selling call options of security, we will call it a call spread, and if it is only puts, then it will be called a put spread.

Depending on the changing factor, spreads can be categorised as:. Thus, we can also distinguish an option spread on whether we want the price to go up Bull spread or go down Bear spread. In a bull call spread, we buy more than one option to offset the potential loss if the trade does not go our way. The following is a table of the available options for the same underlying stock and same expiry date:.

You too can understand how to implement a bull call spread, implement it using Python, and check out the bull call spread payoff diagram. The bull call spread was executed when we thought the stock would be increasing, but what if we analyse and find the stock price would decrease. In that case, we use the bear put spread. Thus, we create a scenario table as follows:. In this way, we can minimize our losses by simultaneously buying and selling options.

You can check out the bear spread options trading strategy to understand how to implement it in Python. A butterfly spread is actually a combination of bull and bear spreads. One example of the butterfly options strategy consists of a Body the middle double option position and Wings 2 opposite end positions. For learners who are aware of options trading and implementing options trading strategies , they can start by expanding their knowledge with this list of reads and projects on options trading.

We have covered all the basics of options trading which include the different Option terminologies as well as types. We also went through an options trading example and the option greeks. We understood various options trading strategies and things to consider before opening an options trading account. If you're interested in options trading, this blog would be the perfect starting point.

However, if you wish to continue learning by yourself, our free options trading course is what you need. It starts with basic terminology and concepts you must know to be able to trade Options. The world of options trading isn't limited to this. Disclaimer: All data and information provided in this article are for informational purposes only.

All information is provided on an as-is basis. What is Options Trading? Definition of Options Options Trading vs. Options trading example What is Put-Call parity in Python? Why is Options Trading attractive? How to open an options trading account?

How to choose a broker for Options Trading? What is options trading? Options trading vs. Stock trading There must be a doubt in your mind that why do we even have options trading if it is just another way of trading. Well, here are a few points which make it different from trading stocks The Options contract has an expiration date, unlike stocks.