Choose A Broker Or Trading Service

Once you're ready to invest in options, you need to choose a brokerage firm. Your firm may offer helpful advice as well as execute your trades. Some firms go further by working with clients to ensure that in both visible and invisible ways, options trading fits into their individual financial plans. They also advise clients about potential objectives and strategies, and outline the risks and benefits of various transactions. Some options investors choose discount firms that charge lower commissions, but don't offer personalized advising services. But others, including both inexperienced and veteran investors, prefer to consult their brokers before opening or closing out a position.

FULL SERVICE BROKERS

MERRILL LYNCH, PRUDENTIAL, MORGAN STANLEY and others will give you advice and tips, generate investment ideas, provide you with quotes and tax information. However, when it comes to commissions, they will charge more than twice what you will pay for a discount broker. 

Wherever you live there are full service brokers that would be happy to accommodate you & your account. But, remember, the most important qualification you are looking for when shopping for a broker is his/her knowledge in the options market. 

For the novice investor, we strongly suggest you start out using a full service broker. It will be expensive, but you must consider that cost as an learning investment. Later on, you can move your account to a discount broker or even have two different accounts, one with a full service broker and one with a discount broker. 

One word of caution with full service brokers: They are also salesmen and very often will try to sell you their brokerage house's stock picks. Just be aware and always do your own homework. 

By the way: commissions are negotiable with a full service broker, depending on your account and how often you trade. 

DISCOUNT BROKERS

SCOTTRADE, ETRADE, FIDELITY and many more, will provide you with a number of services like quotes, news etc, all taking place on-line through your computer. However, they will not provide you with any advice or suggestions. 

There are many ways to place your orders with a discount broker: on the phone with one of their agents, on-line with your computer or even via an internet capable phone. Just starting out? The most comfortable way might be talking to your broker to place an order (full-service or discount). 

Do your shopping, read the fine print. As of today there are discount brokers who will charge you as little as a few dollars per trade. The internet, specialized magazines and newspapers like Barron's, Investor's Business Daily or The Wall Street Journal all will provide you with an array of brokerage companies advertisements vying for your business. 

Regardless of which type of brokerage company, when you open an account they will provide you with a package of forms to fill out. Don't forget to specify you want to trade options and set up a margin account. Ask for their margin account interest rate they will charge you. 

At some point you may have a cash account, usually a money market, within your brokerage account for which you are paid back a nominal interest rate. 

All brokers will send you a free booklet called "Characteristics and risks of standardized options" which gives a very informative and complete view of all options.

Eligibility And Your Broker's Option Trading Agreement

Based on the information you provide in the options agreement, your brokerage firm will approve you for a specific level of options trading. Not all investors are allowed to trade every kind of strategy, since some strategies involve substantial risk. This policy is meant to protect brokerage firms against inexperienced or insufficiently funded investors who might end up defaulting on margin accounts. It may protect investors from trading beyond their abilities or financial means. The levels of approval and required qualifications vary, but most brokerage firms have four or five levels. In general, the more trading experience under your belt, and the more liquid assets you have to invest, the higher your approval level. Firms may also ask you to acknowledge your acceptance of the risks of options trading.

Doing the Paperwork

Even if you have a general investment account, there are additional steps to take before you can begin trading options. First, you'll have to fill out an options agreement form, which is a document brokerage firms use to measure your knowledge of options and trading strategies, as well as your general investing experience. Before you begin trading options, you should read the document titled Characteristics and Risks of Standardized Options, which contains basic information about options as well as detailed examples of the risks associated with particular contracts and strategies. In fact, your brokerage firm is required to distribute it to all potential options investors.

Watch the Margins

You can't purchase options on margin, as you can with stocks. But some brokerage firms require that certain options transactions, such as writing uncovered calls, take place in a margin account. That means if you write a call, you'll have to keep a balance in your account to cover the cost of purchasing the underlying stocks if the option is exercised. This margin requirement for uncovered writers is set at a minimum of 20% of the underlying security minus the amount the option is out-of-the-money, but never less than 10% of the security value.

If the value of the assets in your margin account drops below the required maintenance level, your brokerage firm will make a margin call, or notify you that you need to add capital in order to meet the minimum requirements. If you don't take appropriate action, your brokerage firm can liquidate assets in your account without your consent. Since options can change in value over a short period of time, it's important to monitor your account and prevent being caught by a margin call.