Option Approval Levels For Our Brokerage Accounts

Covered call writing along with all other stock and option strategies require us to open a brokerage account. This process will take more than a simple phone call. All brokerages will require us to fill out an options approval form as designed by its compliance department. Based on the information gleaned from this form, the brokerage will decide which level of trading approval the investor is entitled to. So how do we get the necessary experience without first getting approval to trade? This is a dilemma that is easy to overcome by starting out with simpler and less risky strategies like covered call writing (I may be biased but as you will see, the brokerages agree with me). So before you open and fund a brokerage account, make a phone call to find out the policy regarding options trading approval. For those looking for a place to start searching for a broker, see the “free resources” link on the top black bar of this site. One of the files is a list of several online discount brokers with the contact information.

Options Approval Form

The reason brokerages require us to fill out this form is because of FINRA rule 2090 called the know your customer rule or KYC rule.  Brokerages are required to undertake reasonable diligence when opening accounts so assist in avoiding inappropriate risks on the part of retail investors. They also have their own interests in mind so as to avoid regulatory and legal issues. The form will ask about our trading experience and knowledge as well as our financial resources.

Levels of trading approval

There are no official standards and levels may vary from broker to broker but in all cases the higher levels incorporate the lower level approvals. Here is a graphic of a typical brokerage format for trading levels:

Levels of options trading approval

Level 1:

• Covered call writing (writing as you know means selling)
• Protective puts
• Approved for self-directed IRA accounts

Level 2: Level 1 +

• Call and put buying

Level 3: Levels 1 and 2 +

• Covered put writing (bearish strategy where a put is sold and the stock is shorted)
• Spreads (simultaneous purchase and sale of options on the same stock and class)

Level 4: Levels 1, 2 and 3 +

• Uncovered call and put writing
• Uncovered writing of straddles (both call and put positions with same strike and expiration)
• Uncovered writing of strangles (both call and put positions with different strikes but same expiration)

Level 5: Levels 1,2,3,4 +

• Uncovered writing of index puts and calls

Which level should I choose?

Sophisticated options traders know the level appropriate for their needs. For Blue Collar Investors, Level 1 is the place to be in most (but not all) instances, at least initially. It will allow us to write covered calls and use protective puts if that is part of our strategy. It will also allow us to incorporate our trading into our self-directed IRA accounts. It may also keep us out of trouble! We will be less inclined to try riskier strategies while we are developing our trading skills.

Quick story

A few years ago, a wealthy group of investors flew me out to the west coast to do a private seminar. One investor immediately (way too soon) started trading hundreds of thousands of dollars in covered calls. His brokerage gave him a high level of trading approval because the account was funded with millions of dollars. One day he inadvertently sold the underlying (thousands of shares) and was left in a risky naked (uncovered) options position. It cost him about $150 thousand…not so bad for him but a killer for most of us! (He still needed a box of Kleenex). Had he not had a high level of trading approval, selling the long stock position would not have been permitted and there would not have been the loss.

Conclusion

Find the appropriate level of trading approval and avoid unnecessary risks. For most of us that’s level 1 at least to start. This was a light week for ecnomic reports:

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FREE Webinar on Friday July 19th:

I am proud to be part of the Money Show’s eTradingExpo the largest virtual event produced for active traders online. Here is the link to register for free:

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Market tone:

The market reacted positively this week when it became apparent that short-term interest rates would remain extremely low for the foreseeable future. This was  a light week for economic reports:

• Minutes from the Fed’s June meeting showed that policymakers where split as to when the Fed would cut back on its $85 billion monthly bond-buying program
• There was, however, a consensus that short term interest rates would remain near zero until unemployment improved to 6.5%. It currently stands @ 7.6%
• The Producer Price Index (PPI-A measure of the average change over time in the selling prices of a fixed basket of goods by stage of production, industry, and commodity. It is
  considered a leading indicator for consumer inflation. The “core” PPI excludes food and energy prices—which account for roughly one-quarter of the broad PPI and tend to fluctuate widely—providing a truer reflection of inflationary trends) rose by 0.8%, double the 0.4% anticipated.  Core PPI rose a slight 0.2% from May, allaying any inflation concerns
• Demand for consumer credit (a report of the dollar value of consumer debt, including categories such as credit card use and store charge accounts (known as revolving debt) as well as longer-term loans for autos, education, recreation vehicles, etc. The level of consumer credit is considered a barometer of  consumers’ financial health and an indicator of potential spending patterns) rose to $19.6 billion in May paced by student loans and low interest rates on large purchases

For the week, the S&P 500 rose by 3.0% for a year-to-date return of 19.2%.

Summary:

IBD: Confirmed uptrend

BCI: Moderately bullish favoring out-of-the-moneny strikes 3-to-2

Wishing you the best in investing,

Alan ([email protected])

www.thebluecollarinvestor.com