If you’re reading this, you are probably convinced that options can be a great asset in the battle for investment returns. But before you can trade options, you have to open an options trading account.
Opening this account is a bit different than what you may be used to. Here’s a closer look at how to open an options trading account and get started.
What Is Options Trading?
When you trade options, you enter into a contract that gives you the right to buy or sell a security by a given date. You pay a premium for that right. If conditions aren’t right for you to buy or sell, you can just let the contract expire.
Options trading can be a great way to protect yourself from losses and increase your chances of profits. It tends to appeal to investors when the market is more volatile. You have theoretically unlimited potential profits, and your losses are limited to the premium you pay.
Opening Your Options Trading Account
A broker won’t just automatically give you an options trading account — you need to apply. The broker will make sure you have sufficient trading experience and initial capital.
If you don’t have enough of either, consider opening a paper trading account. This kind of account lets you practice by making simulated trades, and you don’t risk any actual capital.
When you’re ready to open an options trading account, you will need to fill out an application. You’ll likely answer questions about the following topics.
Your Objectives as an Investor
You’ll tell the broker about your primary goal, such as growing your wealth, protecting existing capital or generating steady income.
Your Trading Experience
The broker will ask how long you’ve been trading, what sizes and types of trades you generally make and around how many trades you make annually.
The Kinds of Options You Want to Trade
There are several kinds of options, but these are some of the basic option types you should know about:
- Puts: Give you the right to sell the security.
- Calls: Give you the right to buy the security.
- Spreads: Involve multiple options contracts at once.
- Covered: The seller owns the underlying security.
- Naked: The seller does not own the underlying security.
Potential brokers will ask which types of trades you hope to execute.
Your Personal Financial Information
The broker wants to ensure you have the finances needed to trade. It usually will ask for your net worth, your annual income and your employment status.
Options Approval and Options Levels
If your request is approved, the broker will assign you a trading level. These levels are numbered 1 through 5. Level 1 poses the least risk to the broker, and Level 5 poses the most risk.
Often, if you’re a higher-risk client, you’ll only be able to buy call and put contracts. Your losses are limited to your investment (the premium you pay), and your investment comes from cash in your account. In this way, the brokerage firm does not assume too much risk.
As you prove that you’re financially solvent and have the necessary skills to succeed, you may be able to access more specialized trading options.
To make sure you get all the features you need, you should consider speaking with an options brokerage specialist. These specialists deal with options accounts all day long, and they know better than most who is ready to do complex trades and who should stick with the basics.
On the date of publication, Sarah Edwards did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
