Funding a brokerage account is a necessary part of investing your own money. We encourage you to set up a virtual trading account immediately so you can place the trades discussed in class inside your own account to both get comfortable with the process of placing trades (removing a potential friction point caused by technology) and gain confidence in your ability to get consistent results from the markets.
We believe the real learning is in the doing. Set up a virtual account and use it to follow the trades you see in class. This gets you comfortable with the technology and confident in your ability to get consistent results from the markets.
Option trading is done through a brokerage account. Brokers have become quite innovative, and many have software platforms optimized for both PCs and mobile devices. While almost all brokers allow for trading stocks and ETFs, all but a few of them also offer trading on options. However, not all account holders know how to activate option trading on their account.
If they haven’t already done so, a new account holder needs to apply for options trading authority. When opening a new account or seeking permission to trade options on an already established brokerage account, the process is the same. Brokers encourage traders to read the Characteristics & Risks of Standardized Options before making their first trade. It’s known in the industry as the options disclosure document. You can download a copy of it right here.
The reason your broker will ask you to read through this publication is because the risks of trading options are different and more complicated than trading stocks. The stock market is fairly straightforward. Those who buy stocks risk that the stock will drop in value. Those who sell short risk that the stock goes up instead of dropping as expected.
Because of the additional complexity of options trading, and the way risk varies with each trading style or approach, most brokers establish permission levels as a method of protecting traders. Each permission level allows only certain option strategies to be implemented, though higher levels of trading authority include all the permissions from lower levels.
Getting permission to trade options or seeking a higher permission level requires completing a new application to receive the requested clearance. Once granted, the trader is able to place trades using the strategies they are cleared to trade. Clearance is often granted on some combination of account size, suitability of investor needs, and options trading experience.
Below is a list showing which level of authorization a trader needs for different options trading strategies at several of the more popularly used brokers.
Level 0– Covered calls and puts, covered rolls outs and winds
Level 1– Long puts, long calls, long straddles and combinations
Level 2– Spreads, condors, butterflies, boxes, diagonal spreads, ratio spreads
Level 3– Naked calls and puts, short straddles, short strangles
What follows is a description of how a trader can go about getting the authorization they want at each broker.
Charles Schwab and TD Ameritrade
To begin trading options on either the TD Ameritrade or the Charles Schwab platform, traders first must set up a margin account. This is pretty typical with most brokers. Generally when it comes to options trading, a margin account is required, even if you don’t actually use the trading margin available. Having a margin account helps brokers process your orders when you exercise options.
Once a margin account is established, an application for Schwab’s options trading authority must be completed. This allows the trader to specify his or her experience or education in trading and their financial status as part of getting a desired clearance. If the trader desires to trade option strategies requiring a higher clearance, Schwab/TD requires a new application be submitted.
Schwab/TD has four levels of options trading permission. The highest level, Level 3 for trading naked options requires a minimum of $25,000 in an account and clearance for trading level 3 options strategies. All decisions made about clearance are based on the trader’s desired trading level, experience, and the equity in their account. Be prepared to answer questions to see if you really are prepared to implement the desired strategies.
With Schwab, the right trading education can help traders get approved for higher levels of trading authority.
WeBull is a mobile-focused, commission-free, stock and options trading platform. Unlike Schwab, WeBull offers a trader with the right characteristics to trade any option strategy it offers. WeBull only has a limited number of strategies available to trade, however, the available strategies their clients can trade. The broker limits access to trading strategies based on the suitability, experience and liquid net worth of the client. Depending on how a new trader answers their client-information questions, they might limit access to one of three trading levels.
The platform is fairly new, and policies can change without notice.
Robinhood is a mobile focused broker. However, it is farther along in its progression and can therefore offer additional trading strategies. Like Schwab, Robinhood does require an application to be able to trade options and get permission to trade either Level 2 or Level 3 strategies. Unlike Schwab, this process is simple and can be done on a mobile phone.
The process is simply clicking on the “Account” button, then selecting “Settings.” Once “Settings” is open, find the “Options Trading” section and click the “Enable” button. This brings up the application which is a series of questions about investing experience and objectives, knowledge, and financial condition.
One all the questions have been answered, Robinhood evaluates them and decides whether to grant option trading permission and which level of trading is granted.
Currently Robinhood allows trading of these strategies at the two levels:
There is no minimum requirement in the account size, however, to trade options, traders must have enough money to cover the trade.
Like WeBull, Robinhood is commission free which is great for those with smaller accounts.
Fidelity is historically a more conservative broker, and they take care to be sure they aren’t giving options authority to someone without sufficient knowledge or experience. This means it may be a bit more difficult to get approved for options trading, but it is by no means arduous or impossible.
To get approved, traders must apply for options trading through a paper-based application that they can scan and then email, or simply mail in the paper copy. There are five different options trading tiers available at Fidelity, and like most brokers, a margin account is required for options trading.
Traders can apply for any level if they have sufficient education. But if they haven’t placed any option trades, Fidelity will recommend that you start at tier 1, make some trades, and then apply for the higher levels. Fidelity will not point to one specific factor that could make or break the application, so the more education a trader has, the better.
Fidelity Options Trading Tiers
Tier 1- Ability to write covered calls
Tier 2- Buy calls, buy puts, cash covered puts
Tier 3- Ability to trade spreads ($10,000 minimum requirement)
Tier 4- Ability to trade naked options for stocks ($20,000 minimum requirement)
Tier 5- Ability to trade naked index options ($50,000 minimum requirement)
At Tastyworks there are currently three tiers of trading on the platform. To qualify for each level, traders must fill out the application online when opening an account explaining their objective, experience and financial information and then will be designated to one of the three different tiers of trading levels.
Limited (Tier 1) – Buy stocks, buy options, sell covered calls, sell cash secured puts
Basic (Tier 2) – Sell cash secured puts, do defined risk trades
The Works (Tier 3) – You can go naked and do short shares
At TastyWorks there is no minimum account requirement to receive option trading clearance. But traders must be able to cover the risk of the trade being placed.
Tastyworks explains that they will approve your account based on your options knowledge, trading objectives, and financial standing. If your knowledge is extensive, then you should not have a problem getting approved for all trading tiers. Tastyworks will let the trader dictate the level of options trading clearance to fit the education they have.
E-Trade currently has four different trading levels for options trades.
Tier 1- Allows covered calls
Tier 2- Allows long calls and long puts
Tier 3- Spreads
Tier 4- Allows Naked calls
At E-Trade, tier 3 and tier 4 require traders to have a margin account. When a trader opens an account, they are asked if they want to trade options and at what permission level.
E-Trade charges $0.65 per contact traded which is similar to Charles Schwab. Transaction costs for multiple contracts can become significant.
Interactive Brokers says that they do not have levels, but the trading accounts fall into one of two levels and the options trading authority is implied.
The first level is limited options, and a cash account forces traders into the limited options level. Interactive Broker’s first level allows trading of covered calls and cash secured puts.
The second level has full options capabilities. To fall under the second level traders must simply designate that they want full options trading permission and open a margin account with at least $2,000 in capital.
Interactive Brokers offer Tiered or Fixed commissions that depend on the region.
More to consider
While it’s true that transaction costs are a factor in the decision of which broker to select, other considerations are also important. For example, ease of use. Lower commissions may actually cost more money if trading mistakes persist due to a confusing order interface.
If you already have an account with a broker, it might make sense to remain there and obtain options trading permission at the desired level. That said, the broker you select acts as a silent partner in your efforts to find opportunities in the world of options. Be sure to find one that matches well with your trading needs, interface preference, and desired cost structure.
Below is a video with more information.
OCO (one cancels other) orders can be entered into TD Ameritrade that links a stock or option purchase to a profit target or stop loss order at the same time. This video shows you how.