One of the most common hurdles aspiring traders face is getting their accounts approved for trading certain kinds of options—especially selling uncovered options.
For example, here’s a frequent email I receive from new subscribers…
Dear Jeff, I just subscribed to your Delta Report, and I’m excited to start trading options. But I don’t have any experience in the option market. And my broker requires some level of experience before approving my account for trading options. How can I open an option trading account without any experience trading options?
First, it might help to understand why “experience” is required for approval of an options trading account…
Just before the October 1987 crash, the only requirement most firms had for approving full trading in options accounts was the ability to fog a mirror. In other words, if you were breathing, then you were approved for pretty much any option strategy you wanted to trade.
In September 1987, option premiums started to inflate. Many brokerage firms sold uncovered put options on broad stock market indexes—like the S&P 500 and S&P 100—and recommended their clients to do the same. The premiums were so large, it would’ve taken a “crash” to lose money on those trades.
Of course, the stock market did crash on October 19, 1987. The uncovered put trades that so many brokerage firms recommended to their clients were hugely underwater. And since the margin requirements for that sort of trade at the time were quite mild, traders were way overleveraged on their positions.
They were sitting on HUGE losses. And in many cases, their accounts didn’t have enough money to buy the index at the price they agreed to. They had negative equity—meaning, they could close their positions and still not have enough money in their accounts to absorb the loss.
In that case, the brokerage firm is liable.
In other words: If the brokerage firm lets you take on a position you can’t handle, then the brokerage firm has to make good on the trade.
No brokerage firm ever wants to be put in that situation again. So they’ve set up restrictions on folks wanting to open option trading accounts. You have to show that you have some experience trading options. And you have to have the financial capability to handle the risk.
Almost every brokerage firm will approve new accounts for selling covered call options (a conservative strategy) and for buying speculative call and put options—as long as you have the money in the account to do so.
At most firms, this is considered “Level 1” trading. It’s available to anyone wanting to trade options. As long as you have the cash available to make the trade, there aren’t any restrictions.
But getting approval to sell uncovered put or call options takes a little more work. While these sorts of trades are often lower risk than buying or shorting the underlying stock, the brokerage firm is ultimately liable to fulfill the contract if you don’t have the funds to do so. That’s why firms have more restrictive requirements.
To overcome this objection, you may need to call your broker. Pick up the phone and tell your firm exactly what it is you want to do. For example, if you want to sell uncovered put options on a stock, then make sure you have enough cash available in your account that you can buy the stock at the price you’ve agreed to. In this situation, most firms will approve your account for selling uncovered put options.
Selling uncovered put options is lower risk than buying the underlying stock itself. If your brokerage firm doesn’t grasp this simple concept and isn’t willing to approve your account for this sort of trade after you’ve discussed your intentions, then find another brokerage firm.
In my experience, Interactive Brokers and TD Ameritrade have no problem at all approving accounts for the type of trading I recommend in the Delta Report. I’m sure there are other firms that’ll also approve accounts for my sort of trading.
Again, pick up the phone. Tell your brokerage firm what it is you’d like to do. It shouldn’t have any trouble approving your account for the sorts of trades we do in the Delta Report.
Brokerage firms want your business. If you explain your trading objectives in a way that reduces the firm’s exposure to risk, you should easily gain approval for advanced option trading. Otherwise, look for a more accommodating firm.
Best regards and good trading,
Editor, Delta Report
P.S. I have an announcement to make…
On July 11 at 2 p.m. ET, I’m going live with my next Open Line Q&A. You’ll be able to ask me any question you have about option trading, technical analysis, or my outlook on the markets.
We’ve done a number of these Q&As over the past couple years for subscribers only. But this time, we’re opening it up to anyone interested in learning to trade options. I think it’ll be a crucial skill to have when the market turns later this year. And I want you to be prepared.
To get your questions to the top of the list, submit them in advance to [email protected]. And you can join the Q&A by clicking right here. Be sure to bookmark the page and visit it at 2 p.m. next Thursday.