Options Basics: Getting Started With Options - Part Two
continued from Part One
Are You Eligible?
Basedon the information you provide in the options agreement, your brokeragefirm will approve you for a specific level of options trading. Not allinvestors are allowed to trade every kind of strategy, since somestrategies involve substantial risk.
This policy is meant to protectbrokerage firms against inexperienced or insufficiently fundedinvestors who might end up defaulting on margin accounts. It mayprotect investors from trading beyond their abilities or financialmeans.
The levels of approval and required qualificationsvary, but most brokerage firms have four or five levels. In general,the more trading experience under your belt, and the more liquid assetsyou have to invest, the higher your approval level. Firms may also askyou to acknowledge your acceptance of the risks of options trading.
Doing the Paperwork
Evenif you have a general investment account, there are additional steps totake before you can begin trading options. First, you'll have to fillout an options agreement form, which is a document brokerage firms useto measure your knowledge of options and trading strategies, as well asyour general investing experience.
Before you begin tradingoptions, you should read the document titled Characteristics and Risksof Standardized Options, which contains basic information about optionsas well as detailed examples of the risks associated with particularcontracts and strategies. In fact, your brokerage firm is required todistribute it to all potential options investors.
Watch the Margins
Youcan't purchase options on margin, as you can with stocks. But somebrokerage firms require that certain options transactions, such aswriting uncovered calls, take place in a margin account.
That means ifyou write a call, you'll have to keep a balance in your account tocover the cost of purchasing the underlying stocks if the option isexercised. This margin requirement for uncovered writers is set at aminimum of 20% of the underlying security minus the amount the optionis out-of-the-money, but never less than 10% of the security value.
Ifthe value of the assets in your margin account drops below the requiredmaintenance level, your brokerage firm will make a margin call, ornotify you that you need to add capital in order to meet the minimumrequirements.
If you don't take appropriate action, your brokerage firmcan liquidate assets in your account without your consent. Sinceoptions can change in value over a short period of time, it's importantto monitor your account and prevent being caught by a margin call.
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