Want to Trade Options? Here’s How to Get Started.
If you’re thinking about trading options, there are some important steps that you need to take in order to get started.
Picking the right trading platform/online broker and getting the proper approval for options trading is critical.
Let’s cover some of the basics you need to know to select the right broker, get approval for trading options, and start trading effectively.
Step 1: Choose a Brokerage/Trading Platform
As you select your broker, be sure to get all the details on their commission structure, software, and whether the data you’ll be receiving is in real time. Ask about their fee structure and discounts if you’re funding a new account — many brokers offer incentives for you to trade with them.
Most brokerages allow you to open an options account with relatively simple paperwork — most of which can usually be done online. Options trading is generally allowed in most IRA accounts, but verify this with your broker of choice, as policies can vary.
Once you’ve selected a broker, it’s a good idea to “paper trade” a few times using their platform. That way, you can become familiar with everything and where all the features are.
This is a great time to contact their trading specialists if you have questions about the process or notice something that doesn’t seem right. There’s nothing worse than wanting to make a trade and not knowing precisely how to do it.
|Brokerage Contact Information
Step 2: Understand the Costs
Commissions are only one of the costs associated with a trade. But they are important and should be one of the determining factors in deciding which broker to use.
In addition to commissions, other fees may add to trading costs. Do your research on this… Not all brokers use the same fee schedule, and some charge pesky additional fees — such as confirmation and processing fees.
Finally, the spread between the bid and the ask price is another cost. For example, the bid on an option may be $0.90, and the ask could be $0.95. Market buy orders are completed at the ask price, and sells are completed at the ask.
Bid-ask spreads are a product of the stocks themselves. But some brokerages, such as Interactive Brokers and OptionsHouse, make markets in some stocks and may allow you to be filled in between the bid and ask prices. The more volume a stock or ETF has, the more liquid and tight the option spreads.
Step 2: Get Approval for Options Trading
There are five approval levels with brokerages, each associated with different options strategies. When you’re approved for a certain level, you will have trading authority for strategies approved at that level and lower levels.
Most brokers will start you off with a level 2 approval as long as you have a basic understanding of options. Here’s a breakdown…
|Brokerage Approval Levels
|Covered calls and protective puts
|Long calls and long puts
|Covered puts and debit spreads
|Naked options writing
Each broker sets its own criteria for approving the different account levels. In general, experience and net worth are the most important factors that determine your approval level. Approval will be based on the information you provide on your brokerage account application.
Most investors who dabble in options will need to be approved only to buy or go “long” options, which is a level 2 or 1 at some brokerages.
Be sure to list all market experience you have when answering your broker’s questionnaire so they can get an accurate idea of your background and give you proper approval. Be honest and upfront when doing this task — it’s ultimately in your best interest.
Trading options can be lucrative. But it’s important to know the ins and outs of your brokerage’s platform before you begin trading. Also, pay attention to costs — it’s a crucial part of successful trading. Using a lower-cost broker and limit/stop orders is an easy way to reduce costs.
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