Options: The Level One Blues

When you open your first option trading account (or add option capability to an existing equities brokerage account), your broker assigns you an options approval level. Usually the levels run from Level One to Level Five. Your approval level determines which option strategies you are allowed to use in that account.

The idea behind the approval level structure is that the riskier an options strategy is, the more options experience and/or capital should be required. Here is a typical list of approval levels and the types of trades allowed:

Level 1 – Covered Calls, Protective Puts (i.e. option positions that also include a position in the underlying stock)

Level 2 – Level 1 items plus speculative call and put buying (i.e. buying calls alone as a bullish speculation, or buying puts alone as a bearish speculation)

Level 3 – Level 2 items plus debit spreads (i.e. positions involving more than one option, where the maximum loss is the original net debit paid. For example, bull call spreads, bear put spreads, long butterflies, long calendar spreads, long diagonal spreads)

Level 4 – Level 3 items plus naked short puts and credit spreads (i.e. positions involving more than one option, where the position is entered for a net credit, and the maximum loss may be greater than the original net credit received. For example, bull put spreads and bear call spreads, iron condors, iron butterflies, put ratio spreads).

Level 5 – Level 4 items plus positions involving naked short calls, including short straddles, short strangle, and call ratio spreads.

Having a low option approval level is a challenge since it shuts out many good option trading opportunities. As educated option traders, we would like to be able to use any option strategy that meets our own risk parameters.

The first thing to do along this line is to get the highest option approval level that you legitimately can get. In your options account application, you will be asked what types of option trades you would like to do. I suggest you check all the boxes. You will also be asked what the purpose of the account is. Check all the boxes here too, including speculation. If you only check the box labeled long-term investing, you will receive a low option approval level.

You’ll also be asked about your experience in trading different instruments. Make sure to speak with a live representative and have that person clarify what they mean by experience. Find out if trading in option classes or simulated trading can be counted. Let that person know what options education you have, as this might make a difference in marginal cases.