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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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 (alan@thebluecollarinvestor.com)
www.thebluecollarinvestor.com
Alan,
I attended a seminar last year where the speaker suggested trying to get the highest trading level possible in case you eventually need it. Your thoughts?
Ellen
Ellen,
I must respectfully disagree. If an investor has not as yet mastered the more sophisticated, risky option strategies I see no reason to attaempt to get approval for those levels. This has drawbacks as stated in the “quick story” above but no apparent benefits. Once a retail investor has mastered less rsiky strategies like cc writing and is prepared for more advanced strategies that level of approval can then be requested.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 07-12-13.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Best,
Barry and The BCI Team
New positions this week? Earnings season coming up:
I had a few recent inquiries on these topics. Here is a general response:
I will not be entering any new positions this week for the very reason you stated…no time value. Earnings season is tricky but can be circumnavigated. I will wait for the new report this weekend but let’s look at the current report as an example:
The “running list” (pages 4 and 5 of the report) shows only 7 stocks not reporting in the next contract: The 2 reporting this week and those reporting 8/27 – 9/6. However, look at how many stocks are reporting in the first week of the next contract…I count 20! All become eligible after the report unless you see a huge decline in stock price after the report. Then I would stay away. Aside from these 27 potential candidates you have 10 – 20 ETFs as well. So as I said, it’s a problem but one that we can solve without too much difficulty.
Here’s a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Alan
Most Financially Savvy States: New FINRA survey:
California
Massachusetts
New Jersey
Bottom three (despite our Blue Collar Investors from these states):
Mississippi
Arkansas
Kentucky
Source: Money-rates.com
Premium members:
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
NOT A PREMIUM MEMBER? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
I was surprised to see Scottrade made your list of online discount brokers. I moved my accounts away from them when I started cc writing. They were charging $1.25/contract and a $17 “assignment fee” if you got called out. Once I got half my contracts called out the day before ex-div and the other half at contract expiry – and they hit me with that $17 fee both times!