How to Start Options Trading With Your Current Portfolio
Are you a long-time or even a somewhat new trader who’s found their go-to strategy, but hasn’t dabbled with options? Instead you might see others on Twitter or StockTwits racking up impressive gains, hedging their portfolios and doing all sorts of different things with options. But you might not have options approved for your account, even if you are an experienced trader.
That doesn’t mean the investor isn’t qualified to trade options or that they won’t be allowed to it. It simply means that their broker needs to approve their account for options trading. So how do we do that? Getting approval is usually pretty easy, but it varies by account and by broker.
Let’s look at answering some questions to help investors who are looking to start trading options.
What Are Options Trading Levels?
In stock trading, there are a few different account types. But to keep it simple, there are cash accounts and margin accounts. The former only allows investors to buy and sell stocks with their own funds. With a margin account, they can borrow money from their broker to execute trades. Many seasoned investors recommend not borrowing on margin, and for good reasons. The interest rates are high and it often puts investors into a levered position that they do not properly maintain or evaluate the risk for.
So why then do people use margin accounts?
For starters, it makes short-selling a much easier proposal. Second, it’s a necessary component to unlocking higher levels of options trading. Besides, just because a margin account makes this possible, doesn’t mean we’re using that margin to execute the trade.
So what are these levels?
In a nutshell, brokers categorize different trading strategies into different levels. Generally speaking, most brokers have about four different options trading levels. For instance, here are two different brokers and their various options level.
The first is from E-Trade:
This is from Fidelity:
Remember when we talked about cash accounts vs. margin accounts? While that could be its own separate conversation, one difference is their impact on options trading. Cash accounts can be approved for options trading, but only debit trades are allowed. That being strategies like long calls and puts or buying straddles and strangles. The exception would be “covered” credit trades, such as the cash-secured put or covered call.
Beyond those strategies, investors will often need a margin account. That will be necessary to engage in both credit spreads and debit spreads, as well as naked put sales. That is often Level 3 options trading, while Level 4 and possibly Level 5 (such as with Fidelity accounts) allow for naked straddle and strangle sales, as well as naked call sales.
How to Ask for Options Approval
This process is generally pretty simple. If you already have a trading account, head on over to your account settings. There is usually a tab, icon or button to explore options trading. New accounts can request options trading when setting up. Although, it’s worth mentioning that completely new traders to the stock market should exercise caution when using options, as they are easy to misuse.
In any regard, simply examine your broker’s various options trading levels and request the level you would like access to. Certain account types do not allow for options trading or they have limits to what levels will be approved. For instance, an IRA account is different than a standard brokerage account, in that it does not use margin.
You will also need to fill out a questionnaire, answering questions about your liquid net worth, income and employment. Your broker will also ask about your knowledge of options trading, which strategies you have experience with and request that you “review and understand” several documents.
The process is generally pretty simple and doesn’t take much time.
As we have mentioned a few times now, the experience will vary from broker to broker. So will the different requirements and options levels. However, it’s up to each trader to determine what their goals and needs are when it comes to options trading.
For instance, if a trader’s goal is simply to be able to hedge their position with a protective put or generate income via a covered call, that’s generally a pretty easy strategy to get approved. So long as the trader has the funds to purchase at least 100 shares of the security they’re looking to trade options on, there shouldn’t be much of an issue. However, those looking to enter more complicated positions will need (and want) a margin account.
Margin accounts require $2,000 to open and provide investors with a lot more flexibility. First, they don’t have to worry about trading settled funds like cash-only accounts do. Second, a number of different options trading strategies become available. And remember, just because you have a margin account, doesn’t mean you have to trade on margin.
Keep in mind though, options trading is difficult. It’s much more difficult than trading stocks. While they add plenty of flexibility to one’s account in terms of what the investor is now capable of doing, options have many more variants compared to stock trading. There’s volatility measurements, expiration dates, deltas and a whole host of considerations.
That said, with proper preparation, investors can add this versatile tool to their investing toolbox.