What Options Trading Level do I need?

Trading options typically requires approval from your broker.  Brokers want you to trade as much as possible, so they don't want to get in the way of your trading.  However, they also need to protect themselves by ensuring options traders fully understand the risks in trading them. 

To qualify for trading options, most brokers ask that you apply for the "level" of options trading that you understand and need.  Typically, the broker wants to ensure you have sufficient experience and understanding in trading options so that traders don't unexpectedly lose money, taking on more risk than they realize.

There are many ways to use options. Some place more of your money at risk than others.  It's these higher-risk trades that require extra qualification from your broker. Typically, the higher the option level number, the greater the requirements to qualify.  A higher level typically includes all the abilities of the levels below it.  Since the amount of funds in an account can affect approval, option trading levels are often applied per account rather than per person.

Examples

Most brokerages have 4 or 5 levels of option trading approval.   Here's an example of a 5-level definition.  Check with your broker for how they've set up their levels. 

• Option Trading Level 1 grants the ability to write covered calls on stocks you own, and sell cash-secured puts.
• Option Trading Level 2 grants the ability to buy call and put options you don't yet own, and sell the options you own.  These are sometimes known as directional trades.  In other words, you can go long calls and puts.
• Option Trading Level 3 grants the ability to trade debit spreads.
• Option Trading Level 4 grants the ability to trade credit spreads.
• Option Trading Level 5 grants the ability to sell calls and put options without having to own the underlying stock. These are known as "naked" calls and puts, or short selling of options.

Some brokers combine the requirements differently.  In the example above, level 4 is needed for credit spreads, while at another broker, Level 3 may meet that requirement.  For example, here's TDAmeritrade's 4-level approach at the time of this article's creation.  These can change, so you want to check with your broker to see what their current requirements are:

• Option Trading Level 1 grants the ability to write covered calls on stocks you own, and sell cash-secured puts.
• Option Trading Level 2 grants the ability to buy options you don't yet own and sell the options you do own. 
• Option Trading Level 3 grants the ability to trade credit or debit spreads.
• Option Trading Level 4 grants the ability to trade naked calls or puts.

Note that at this broker, level 3 allows for both debit and credit spread trading, which is different from the first example.

Qualifying

To qualify for a level, the trader must verify that they have sufficient experience in trading options at that level, and that sufficient funds exist in the account for the given type of trading, along with other requirements.  This is usually done by completing a broker-provided form to apply for the desired level.  A riskier (higher) level generally requires greater experience and more funds in the account.  Speculation can also play a part in approvals, where an account classified as speculative may be easier to get approvals for than one that's tagged as more safety-focused.

Since experience is required to trade the types of trades at the higher levels, it's a catch-22 in that it's hard to gain experience if you're not allowed to do the trades.  Your broker may offer paper trading, where you can practice various trades as you learn.  Traders will often start out trading the lower-level approaches for some time and then gradually move up to the higher levels. 

If you feel that you'd like to qualify for a higher level but are having trouble qualifying, first, make sure you truly are qualified to do that type of trading.  That is, you fully understand how options work, you fully understand the risks, and you're willing to take the losses that options trading can generate.  After all, losing more than you used to get into an option in the higher levels of options trading is possible.  That's different from long stock trading in that your maximum risk is losing the entire value of the stock you bought.  Some options plays, such as selling some naked options, can require you to owe more than you paid for the option.  So be honest in your applications, and only trade the setups that you sincerely understand and have experience trading.  And make sure to get the training and practice you need to help you get to whatever level of understanding you need. 

If you're struggling to get approval from your broker, call them to ask what's required to qualify for a level.  Explain why you feel you're justified in getting that level of trading approval.   Sometimes, just speaking with the broker representative and explaining your understanding can help you get the desired access.  If you aren't meeting their requirements, find out what you'll need to change to qualify, and make the required changes.  Then call them back after you've met those requirements.  And if you can't get the level you sincerely feel you're qualified for, contact other brokers to see if you meet their requirements.  You'll find that different brokerages have different requirements.

Option trading can be lucrative for traders willing to do what's necessary to learn them.  Options can provide amazing leverage and help you to reach your trading goals more quickly once you fully understand how and when to use them correctly.