The question of what level of options trading you need isn’t up for debate. It’s a question for your broker…
If they only give you Level 1 clearance, that’s what you need…
A level of options trading that suits your experience and risk tolerance.
Why? Because options trading has a steeper learning curve than stock trading. It’s a popular trading niche, but there’s more risk. I’ve seen new traders blow up their accounts all the time.
And if you can’t be profitable with simple strategies, there’s no way you’ll find sustained success with more advanced strategies.
I don’t trade options, but I’ve learned about them from watching my former student Mark Croock. He’s an instructor in my Trading Challenge, as well as in his own Evolved Trader program. Most of his $4 million career earnings are from options trades.
What’s the difference between options trading levels? Which level suits you? Read on to learn all about it!
Table of Contents
What Factors to Consider Before Getting Into Options Trading
Different types of traders need different trading levels. How do you determine the trading level that suits you? That depends on what you want to get from options trading.
Here are several factors to consider before trading options:
Trading Goals
Every trader’s got something to shoot for. Define your goals well before starting options trading.
Trading without a clear goal makes you more vulnerable to bad decisions. Why? Because greed and emotional trading take over — and those are a trader’s worst enemies.
Like the stock market, your goals don't care how you feel so curb your emotions! pic.twitter.com/7YnnWPt9Od
— Timothy Sykes (@timothysykes) August 6, 2018
Risk Tolerance
Your risk tolerance differs from other traders. Maybe you’re comfortable making big leaps for large potential profits. Or maybe you’d rather trade conservatively, even if the returns are smaller.
Different types of options have different risk levels. Your risk tolerance will define which type of option you’ll trade the most.
Trading Plan
Trading without a plan is just gambling. You’ll make random trades that’ll probably lose you money.
That’s why you need a trading plan. And this plan needs to be tailor-made to fit your goals and risk tolerance.
Current Financial Situation
Your current financial situation matters. It dictates how much money you can spend on trading. Don’t trade money you can’t afford to lose — that’s an easy way to go broke.
New to options trading? Check out my articles on buy-to-open orders and why options trading is risky.
How to Get Options Trading Approval
The procedure for options trading approval differs for every broker. But most of them have this in common — they don’t allow you to trade options right off the bat.
Brokers do this because options trading can be risky for both the trader and their broker.
Options trading usually isn’t unlocked by default. You need to be approved for trading options. Requesting approval usually entails completing an application form, where you answer questions about your trading experience, goals, personal finances, and what options strategies you’d like to trade.
It usually takes one or two business days for the broker to review your form. If you get approved, you’ll start at the level of options trading your broker approves you for. You can apply for level upgrades later as you gather more experience.
Some online brokerages allow you to make options transactions right off the bat. All you need to do is apply for options trading while creating your account. Check with your broker for specifics if you’re planning to trade options.
What Are Options Trading Levels?
Options trading levels are phases of permissions set by a broker. Each trading level represents a set of options strategies. And each options approval level is more complicated than the last.
Brokers give you gradual access to options strategies. Why? Because advanced strategies rely on more leverage than you may know how to handle.
Options trading restrictions protect newbie options traders from themselves.
There are no standard criteria for trading level eligibility. Each options broker has different considerations and may have varying approval criteria. Check with your preferred broker for more details.
The trading level hierarchy also differs from broker to broker. One options broker may have a three-level system, while another has a five-level system.
There’s one common thread. The lowest approval level will have basic strategies. And the highest approval level will have the most advanced strategies.
Here’s a look at a common four-level options trading approval scale:
Level 1: Covered Positions
Most brokers start inexperienced traders at Level 1. This level has covered positions, which include covered calls and covered puts.
Here’s what these two positions entail:
- Covered calls: Buying a covered call will let you sell a stock you own at an agreed-upon strike price before or on a specified expiration date. You can also write covered calls to get extra income when selling stocks. Traders buy covered calls when they think share prices will rise.
- Covered puts: A covered or cash-secured is in some ways equivalent to a short position. Like covered calls, you can also write covered puts to get money from the options premium when somebody buys the contract. Traders buy covered puts when they think market prices might fall.
Level 2: Long Options
At Level 2, you get access to buying long options positions. Long calls and long puts are some of the most common types of options contracts. Here’s what they do:
- Long call: This is the standard call option contract. Buying a long call means you have the right to buy a stock at a certain strike price before or on its expiration date. You exercise a long call when the share price exceeds the strike price. It’s best used if you think a stock’s price will rise in the future.
- Long put: A long put option gives you the right to sell a stock at a certain strike price before its expiration date. It becomes executable when the stock price falls below the strike price. This means you can sell the stock at higher prices, then buy it again at a lower price, like a short sale. Long puts are best used if you think stock prices will fall in the future.
When you buy long options positions you have the right to exercise the option, not an obligation. Even if the option’s asset price hits its strike price before expiration, you don’t have to execute.
Depending on how far away the option’s expiration is, you may choose to sell the option to another option buyer. Or you can just let it expire — the only money you’ll lose is the premium.
What’s a strike price? Read more in my post about strike prices in options trading.
Level 3: Option Spreads
Most brokers allow intermediate traders to access options spreads. An options spread is a more advanced strategy for experienced traders.
Here, you trade multiple option contracts for the same underlying security. These contracts should have different strike prices and/or expiration dates.
Traders often use spreads to hedge their bets, limiting risk. But option spread trading also limits their maximum gains.
Here are two common types of strategies on this level:
- Vertical spread: A vertical spread means you buy multiple options contracts. These contracts have different strike prices but expire at the same time. This creates a “Plan B” when the stock price doesn’t hit the price threshold you’d originally projected.
- Horizontal spread: In a horizontal spread, you buy long- and short-term options. These options have the same strike prices but different expiration dates. This gives you a chance at more modest gains from your long-term options to offset losses of premiums from your short-term options.
There’s also a combination strategy called a diagonal spread. Most brokers restrict access to spreads because there are a lot of moving parts. They can be an awesome strategy, but they can also lead to overtrading.
Read my post about option spreads to learn more about this strategy.
Level 4: Uncovered Calls and Puts (Naked Options)
Most brokers lock uncovered options until the final level. Uncovered or naked calls and puts can have potentially unlimited loss potential. That’s why these trades are restricted to the most advanced, and well-resourced, options traders.
Writing an uncovered call is like a covered call. You’re selling the right to buy a certain stock at an agreed-upon strike price and expiration date.
The key difference between covered and uncovered calls is the stock ownership. In naked calls, you don’t hold any shares of the underlying security.
The best-case scenario for a naked options writer is for the options to expire. This means you can receive money from the premium without buying any stock.
What happens if the option holder exercises their contract? The naked options writer needs to buy the stock for them.
The worst thing that could happen here is if the prices are far beyond the strike price. This is where you’ll potentially experience unlimited losses.
This dynamic is similar in buying uncovered puts. Like short selling, you’ll be on the hook for buying the stock if the option is exercised.
Unlike short selling, options contracts are multiplied by 100.
Never forget what I think about newbies short selling…
ANOTHER NEW MUST READ BLOG POST: https://t.co/jcYs2heLFB How To Short Sell (APRIL FOOL'S DAY, I DON'T THINK ANY NEWBIE SHOULD BE SHORTING RIGHT NOW, IT'S FAR TOO DANGEROUS!)
— Timothy Sykes (@timothysykes) April 1, 2021
Thankfully, brokers don’t let new traders close to these strategies.
How to Move Up an Option Trading Level
Increasing your options approval level is different with every broker. But the most common way is to request an upgrade. You can usually do this through a menu on the broker’s website or app.
Most brokers require you to complete another application form for a level upgrade. Answer all the questions, and wait for the broker to review your application. If you’re approved, you can start trading new strategies.
Read my guide to choosing the best options broker so you know what’s ahead of you.
Key Takeaways
The level of options trading you need depends on your trading goals and risk tolerance. You also need trading experience for more advanced options trading strategies.
How do you build trading experience? Learn from experienced options traders. I’ve got a great way you can do just that — sign up for Mark Croock’s Evolved Trader program!
When you sign up for Evolved Trader, you’ll be learning from a skilled teacher — as well as a damn good options trader. Mark’s guidance and mentorship will help you level up in more ways than one, and deal with the obstacles that every options trader faces on the way.
What level of options trading are you approved for? Let me know in the comments!
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