Opening An Options Account

The Smart Profits Report: Issue #162
Monday, November 22, 2004

Opening An Options Account: Smart Profits Basics Part 1
By Karim Rahemtulla
Chairman, Mt. Vernon Research

If you’ve been reading this e-letter for while, you’ve seen the kinds of enormous gains you can make trading options. Maybe you even did a little paper trading just to see in more detail how it works. And now you’re ready to start making some money with options. Now what?

Well, the first step is opening an options account for trading, which means getting clearance from the brokerage. This is not always easy.

In fact, the process can be a little frustrating, but by knowing what to expect and preparing for it in advance, you’ll get up and running with less hassle and less time. Which means you can start profiting sooner.

And it starts with getting clearance from the brokerage…

Clearing the “Clearance” Hurdle In a Single Bound

You’ve never seen this written anywhere, but you’ve heard it, even if phrased with devious politeness…

“You don’t have a clue about options. For that matter, you don’t have a clue about investing.

“I do. I am a broker. To get to where I am, I had to pass an exam, on my third attempt. And, now I can tell you if you are qualified to trade options.

“What? Don’t you get it? You don’t understand money unless you are a broker. Oh, by the way, if I screw up, then you MUST use arbitration (run by a committee of insiders who love my company) to try and recover any funds from me…”

If nobody ever said those exact words to you, be sure it’s exactly what 99% of brokers think.

That, in my opinion, is what the disclosure SHOULD say at the bottom of every stock and options agreement that you must sign before you can trade. And you might even throw in this:

“Good luck and thanks for leaving your hard-earned money with me to control - and of course collect a piece of - every time you decide that you know better.”

You’re Bright, Rational and Have the Money… Not Enough!

You would think that a 50-year-old person of sound mind and body, with 30 years of investing experience, would know more than an 18-year-old just out of high school.

But, no. Brokers are often in a position to say that YOU just may not be “suitable” to trade options. And while there are good brokers out there, the majority of brokers are just not qualified to determine your suitability to trade options.

Yet they do, and on a regular basis…

The suspicion that every customer is incompetent is a rampant myth in the brokerage world.

It’s rather like getting that first job. To get one, you have to prove you’ve done well at your last job, so you have to get a job to get a job! If you have never traded options before, you may not get the chance to participate in this high-profit market until you can prove you’ve participated before.

Start With Covered Calls and Go From There

Here’s how it works: In order to trade options, you must fill out an application. The application asks you pointed questions. And, unless you answer that:

(1) yes you are willing to lose everything and

(2) you won’t get upset if you do and

(3) you won’t sue the brokerage firms regardless of how negligent they are

You’re in trouble. Chances are you will not be allowed to trade any options except covered call plays.

Okay, so I am exaggerating a bit. A little bit. In reality the options agreement is reviewed by each firm’s options department to see whether you should be allowed to trade different options strategies. You may be able to buy puts and calls, but not engage in straddles, for example.

But more likely, as a beginning options trader, you may not be allowed to do anything except trading covered calls. Why? Because there is absolutely no risk to the broker if you are trading against a stock you already own.

At the start, your chances are best if you have had a regular account for a while, have plenty in it, and are willing to sign the form saying that you are willing to lose money and understand the risk.

Some Brokerages Make It Hard - Others Make It Easy

In later columns, I’ll tell you how to manage your money to offset this risk. But for today, think hard about how much risk you can stand. If you can take a little bit of a hit, then the broker is probably right. Covered calls are probably your best strategy.

But what if you’re all set to go mentally and the broker still stands in your way. Then you have to take charge. I’ll tell you how to get around this hurdle in the next letter.

Good Trading,

Karim Rahemtulla

Today’s Smart Profits Cribsheet

Today we talked a good deal about covered call options strategies. For more on what covered calls are, visit our handy online Smart Options glossary full of useful options-trading terms.

Related Articles: