Open an Options Account
The Smart Profits Report: Issue #111
Monday, May 17, 2004
Open an Options Account: Not Always a Simple Task When Dealing With Brokers
By Karim Rahemtulla
Chairman, Mt. Vernon Research
You’ve never seen this written anywhere, but you’ve heard it, even if phrased with devious politeness when trying to open an options account…
“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 it 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 emerging market until you can prove you’ve participated before.
The Process Begins with You on the Defensive
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:
- Yes you are willing to lose everything.
- You won’t get upset if you do.
- 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 (I’ll explain a straddle in a later issue, or check the Cribsheet below.)
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
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Today’s Smart Profits Crib Sheet
- When the Market Volatility Index is low, premiums should be low, too. And in the options world, low premiums are great for straddle and strangle positions. These techniques are best used when you’re unsure of which direction the market will take. Straddles and strangles can relieve you from having to choose the direction, find out more in Smart Profits #381, The Market Volatility Index: Using The VIX To Straddle And Strangle Stock Options.
- Today we talked a good deal about covered call options strategies. For more on what covered calls are, visit our handy Smart Profits Glossary full of useful options-trading terms.
Related Articles:
- Secrets to Getting Started In Options - Part 1
- The Six Key Tools for Options Trading
- Getting Paid to Place Limit Orders On Your Favorite Stock
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