How to Open an Options Account

Book: Understanding Options 2E

Type: Chapter 4

Difficulty: Beginner

Reading time: 10 min

Core idea

Options accounts require separate approval

You cannot simply start trading options by clicking a checkbox in your existing brokerage account. Brokerage firms are required to evaluate whether you have sufficient knowledge and financial resources to trade options, and they grant access through a tiered approval system. The tier you are approved for determines which strategies are available to you.

The approval process involves completing an options agreement — essentially a questionnaire about your investment experience, financial situation, and knowledge of options. The broker uses your answers to assign an approval level (typically Level 1 through Level 4 or higher).

What each approval level unlocks

The most conservative strategies require the lowest approval level. Level 1 typically allows covered calls — selling calls on stock you already own. Level 2 adds buying calls and puts. Higher levels add spreads, selling naked puts, and eventually selling uncovered (naked) calls — the most risky strategy of all.

For beginners, Level 1 and Level 2 cover virtually everything in this book. Getting approved for higher levels before you have the experience to use them safely is not an advantage.

Don't stretch for the highest approval level

Some beginners overstate their experience on the options agreement to get a higher approval tier. This is a mistake. The approval levels exist to protect you from strategies whose risks you may not fully understand. Start at Level 1 or 2, learn those strategies thoroughly, and request a tier upgrade only when the more advanced strategies genuinely apply to your situation.

Why it matters

Margin accounts and options are separate questions

A margin account (borrowing money to buy stocks) and an options account are different things. You do not need a margin account to trade covered calls or to buy options. You do need one for certain advanced strategies (selling uncovered calls, for example). If you are new to options, a cash account is sufficient for everything covered in the first half of this book.

One important exception: IRA and tax-deferred retirement accounts typically have restricted options access. Most allow covered calls and some defensive put strategies, but naked calls and high-leverage speculation are generally prohibited. This is not necessarily a disadvantage — the conservative strategies available in a cash or IRA account are the ones that belong in a retirement portfolio anyway.

Commissions have dropped dramatically

In the early days of online trading, options commissions were significant enough to affect strategy selection. As of the 2nd edition of this book, commissions have fallen to as little as $10 per trade (and in some cases lower). For most retail strategies, commission is now a minor consideration. The main cost driver is the bid-ask spread, which is covered in later chapters.

Key takeaways

Key takeaways

• Options require a separate approval process beyond a standard brokerage account — you complete an options agreement that determines your approval tier.
• Approval tiers (Level 1 through Level 4+) control which strategies you can use. Level 1 allows covered calls; Level 2 adds buying options.
• You do not need a margin account for covered calls or buying puts — a cash account is sufficient for the conservative strategies.
• IRA and retirement accounts allow options but restrict the most speculative strategies, which is appropriate for long-term accounts.
• Commission costs have fallen sharply; the more important cost to monitor is the bid-ask spread on the options themselves.
• Overstating experience on the options agreement to reach a higher tier is counterproductive — it exposes you to strategies whose risks you may not understand.

Mental model

click to zoom

Options approval tiers and the strategies each unlocks

Read it as: Start at the top — Level 1 is where every options account begins. Move down only when you have real experience with the strategies at each level. The green zone (Levels 1–2) covers nearly everything a retail investor needs.

Practical application

1. Open a standard brokerage account first if you don’t already have one. Choose a firm with good options education tools and responsive customer service — not just the lowest commissions.

2. Complete the options agreement honestly. Report your actual experience level and financial situation. The approval tier you receive is appropriate for where you are; you can request an upgrade later.

3. Start with a Level 1 or Level 2 account. Covered calls (Level 1) and buying calls/puts (Level 2) are the strategies in Chapters 6–18 of this book. There is no need for higher access until you have significant experience.

4. If using an IRA, check which strategies your custodian allows. Most allow covered calls and protective puts — the two most useful conservative strategies. Some allow spreads. Very few allow naked options.

Example

The teacher’s retirement account

Maria is a high school teacher with a self-directed IRA holding 200 shares of a large-cap technology stock. She wants to learn options to generate extra income from her holdings.

She contacts her IRA custodian and completes the options agreement. Her custodian approves her for Level 1 (covered calls) in the retirement account — selling naked options is not permitted, and borrowing on margin is not allowed.

This turns out to be exactly what Maria needs. By selling covered calls on her 100-share position each month, she generates between $80 and $200 in premium income depending on market conditions. Her retirement savings grow through both stock appreciation and premium collection, with no additional capital required.

Related lessons

Related

Welcome to the Options Market The four uses of options — income, protection, hedging, speculation — and why they exist. The Fascinating Characteristics of Options Core vocabulary: calls, puts, strike price, expiration, premium — the language you need before any strategy. The Joy of Selling (Writing) Covered Calls The Level 1 income strategy — accessible immediately after account approval.