Last week, I shared the 10 essentials of options trading you need to know to when starting out as an options trader.

And today, I want to walk you through the process of opening an options trading account.

Now, you may already have one: like a retirement account, such as an IRA or a 401(k). What you may not know is that you can trade options in your retirement account. If you’d like to use your retirement account to trade options, then you want to contact your broker to get your account converted for options trading.

If you don’t already have one or would prefer using a separate account for options trading, click on the video below to learn how…

Remember, as I mentioned in this video, you’ll need to get your options clearance before you can place your first trade.

While this won’t get you access to any classified information, it will get you approved to start trading options.

You’ll need to answer a series of questions for your broker to determine which types of options you’ll be able to trade in your account.

And I’ve broken down the process of opening your options account into five very easy steps.

How to Get Your Options Clearance

Before we get started, keep in mind that the information brokers collect will be the same, but the specific order and phrasing of the questions you’re asked could vary.

The examples I’ve give below are based on Charles Schwab’s application process, as it’s one of the most popular brokers out there for options traders.

Let’s jump in…

Step 1

The first thing you need to do is get whatever clearance lets you buy “calls” and “puts”. Clearance levels can vary from broker to broker but typically include four levels. (Some include five.) Here are the clearance levels for Charles Schwab…

The other thing your broker will ask you is whether or not you want “margin trading” or “margin” added to your account.

A margin account is basically a “loan” given to you by your broker. This allows you to enter certain trades that could potentially end up costing you more money than you initially put in them.

Now, let’s move on to the next step…

Step 2

After you’ve chosen the clearance level you want, your broker will then collect your personal information (such as your income, employment, and trading experience). Like the clearance levels, these questions could vary depending on your broker, but the purpose is the same: verify your identity and determine your suitability for options trading.

This is what you can expect using Charles Schwab’s options application…

As you can see, this information is really no different from any other financial application you might complete to, say, open a checking, savings, or retirement account.

Step 3

When you get to questions about your annual income and net worth, remember that this is only used to determine what types of options you can trade – as well as to verify your identity. It’s similar to the information you’d provide when filing your annual tax return too…

Charles Schwab (and many other brokers) ask for both “total net worth” and “liquid net worth.” As the definition in the margin explains, “liquid net worth” includes all investments that can easily be turned into cash, including funds, stocks, and so on.

However, “liquid net worth” does not include any real estate investments. So don’t include the value of your house here.

Your “total net worth” will include all of your “liquid net worth,” as well as any illiquid assets you may own (such as real estate).

And don’t worry if this seems too complicated to figure out on your own… Charles Schwab, for example, has a Personal Net Worth Worksheet you can use. There are also plenty of calculators and other helpful tools online you can use, such as the What is My Net Worth calculator.

Step 4

The second-to-last step in getting your options trading clearance is providing some information about your trading experience and knowledge.

Now, this isn’t a trick question… you’ll want to check the box under knowledge level based on how much you know about options trading.

If you’ve never heard of options (until now of course), you’ll want to check the box next to “none” under “Knowledge Level.” If you’ve heard of options before, then you’ll want to check the box next to “limited.” If you’re pretty familiar with options, you’ll want to check the box next to “good.” And if you know options like the back of your hand, then go ahead and check the box next to “extensive.”

The same thing applies to “options trading” below…

If you’ve never traded options before, you’ll want to check the box next to “none.” If you’ve placed an options trade before but are still pretty new to them, you’ll want to check the box next to “limited.” If you trade them pretty regularly, you’ll want to check the box next to “good.” And if you’re trading options like a pro, then go ahead and check that box next to “extensive.”

Step 5

Now, the only thing left for you to do is sign and mail, fax, or upload (depending on your broker) your application. That’s it!

Next Steps

Once you get your clearance, I’d also suggest practicing placing your first few trades using your broker’s “virtual trading” or “paper -trading” system. These allow you to enter, follow along, and exit a trade as per usual but without using any money.

Now – of course – that also means you can’t make any money. But it’s a great way to get acquainted with options in general and your broker’s platform in particular. I recommend all my readers use paper-trading until they get comfortable – in fact, I wish I’d used it back when I first got started with options.

And remember, if at any point you’re not sure what to do, never hesitate to contact your broker. Since you’re their customer, they owe you time on the phone to make sure you’re buying the option you want to buy.

I hope this information has helped to show you just how easy it is to open an account and get clearance. Next week, in Part 7, I want to cover another order types – what they are and when to use them.

To your continued trading success,

Tom Gentile
America’s Pattern Trader