Why You Need Permission to Trade Options

As the mother of three young boys, my signature is in high demand.

Here recently, my eldest came home from school waving a piece of paper.

His class was going on a field trip to a rodeo — but he could only join if I gave my permission first.

Like all kids, he seemed to find this an unnecessary hassle. Who needs Mom’s permission, anyways?

But I sat and read through every word. I needed to know that the risks were low, and my son could handle a trip like this.

As adults, we can make these decisions for ourselves. We usually don’t need to get anyone’s approval before we decide to do something.

Except, that is, when it comes to trading options…

Your Permission Slip to Trade Options

I’ve mentioned a few times that options are different than stocks. One of those differences is that your broker must approve you before you can trade.

When you open a brokerage account, you can immediately trade stocks. But if you want to trade options, you must ask for permission. The Securities and Exchange Commission (SEC) requires your broker to do this.

The SEC was created to protect investors. They decided some investments are so risky they should limit access. Options fall into that category.

We might be tempted to huff and roll our eyes, much like my son. After all, we’re adults! We can make our own decisions!

But the truth is, there are risks to trading options that don’t exist in stocks. Forcing investors to seek broker approval ensures they understand that. It’s like a speed bump.

So, if you’re facing that speed bump, here’s how to overcome it…

What Your Broker Needs to Know

Approval is a simple process. You’ll fill out an online form asking a few questions.

The first question usually asks about your investment objectives. Choices include capital preservation, income, growth, or speculation. Your answers reveal which strategies are right for you.

If your goal is capital preservation, your broker may approve you for covered call strategies. This means you can sell calls on stocks that you own to protect against losses. That helps preserve capital.

For those seeking income, brokers may approve options selling strategies. If you answered “growth” or “speculation,” you’ll typically be approved to buy calls or puts. These are all more aggressive strategies and best suited for accounts with objectives to maximize gains.

Your broker will also ask about your trading experience. They want to see that you have at least some experience in the market. In the past few years, some brokers have lowered their experience requirements.

Brokers also ask about your assets and income. This helps them ensure you can accept the risks of trading.

Depending on your answers, your broker can approve you for one of five levels. In general, the levels allow you to use different strategies:

• Level 1: Sell calls on stocks you own (covered calls).
• Level 2: Buy calls and puts (speculating).
• Level 3: Sell calls and trade more advanced strategies like spreads.
• Level 4: Increases the number of strategies you can trade.
• Level 5: Sell options on stocks you don’t own (naked options writing).

Levels are cumulative. If you are approved at Level 4, you can trade strategies covered in Levels 1, 2 and 3.

If you aren’t approved at the level you’d like, it may be for good reason. You might want to continue familiarizing yourself with options before re-applying for a more advanced level.

But if you’re certain you’re ready, you can always apply with a different broker. Brokers set their own requirements, so there’s a chance you may be able to qualify at a different one.

And if all else fails, try to get a broker on the phone. Describe exactly what you want to do and how you plan to do it. Most often, they’ll approve you.

These rules date back to the days when full-service brokers managed accounts for investors. Unscrupulous brokers could generate large commissions trading options. The approval process ensured investors understood exactly what they were accessing.

Now, with so many traders managing their own accounts, this might seem like an unnecessary process. But it really is designed to protect investors.

Options aren’t right for everyone. Some strategies aren’t appropriate for all traders. The approval process highlights this and slows traders down, ensuring they think about how they plan to trade.

Regards,

Amber Hestla
Senior Analyst, True Options Masters

Chart of the Day:
Gold — The Last Resistance

By Mike Merson, Managing Editor, True Options Masters

(Click here to view larger image.)

I was a bit early calling for higher gold prices, but I don’t think I was wrong.

Amid all the volatility of this week and last, gold has quietly notched about a 3% move higher. It’s back above the short-term upward resistance, and is facing one last piece of horizontal resistance until it moves to new highs.

It’s easy to forget about gold when you consider the scope of the whole market. It’s just a rock… sitting there.

But investors have used gold for thousands of years to protect their wealth in times just like these. This seems almost ingrained in our human DNA. We see gold, we think “safety.”

Most of everyone’s favorite stocks, on the other hand, have been around for just a century at the high end.

I think rumors of gold’s death have been greatly exaggerated. And you don’t have to settle for the small gains we see in spot gold prices. Trade the swings using options on the gold miners ETF (GDX) for a little bit of leverage on what’s sure to be another big leg higher.

Regards,

Mike Merson
Managing Editor, True Options Masters