What strategies do you offer online? In today's world, your broker should offer online trading tools and capabilities. One important question to ask is, what strategies can I initiate online. While many firms offer the ability to trade complex positions like butterflys, condors, and ratio spreads, many do not. If trading advanced options trades online is important to you, ask the firm if it offers these capabilities BEFORE funding an account.
How much is it going to cost? It's frustrating to put on a three-legged spread like a butterfly and get charged $70 or $80 for the trade because the firm assesses high commissions per contract. Most firms don't anymore and some even offer trades for as little as a few dollars per contract. Check the firm's web site for commission rates. These are sometimes complex, but worth understanding if you plan on doing a lot of spreads and other advanced strategies. Of course, commissions on stock trades are important if you plan on using combination plays like covered calls, protective puts, collars or gamma scalps.
Do you charge more for broker-assisted trades? We all need a little help sometimes and some firms charge more for the assistance of a live broker when executing trades. The amounts can vary. If you don't need much help, it won't matter. On the other hand, if you're on the road a lot, are relatively new to options trading, or think you might need help, find out how much the firm charges for broker-assisted order execution.
What is the cost for exercise and assignment? Exercise and assignment is a fact of life when actively trading options. Exercise happens when an options investor says they want to buy (for calls) or sell (for puts) shares of the underlying asset. When this happens, another party gets assigned on the contract. Brokerages charge fees for exercise and assignment and this cost is a factor to consider when choosing a broker as well.
Tools, research and ideas. What kinds of options-related research does the firm provide? I need news, earnings and economic data. Does the firm offer commentary, web chats, or tools for analyzing options? Some firms offer systems to screen for certain stocks based on fundamental or technical factors. Others also offer more advanced options-trading screeners that help search for names with high and low levels of implied volatility, volume and put-to-call ratios. Stock and exchange-traded fund research is worth checking out as well.
How good are your risk graphs and payoff charts? Risk graphs give traders a visual view of the potential profit and loss from an options position. Sometimes called pay-off charts, they're extremely helpful in seeing the potential risks and rewards of spreads and more advanced strategies. It's true that a picture is sometimes worth one thousand words. Risk graphs can be very simple and show only the profit and loss at expiration, but some firms also more advanced charts that let you see the risks and rewards in the months, weeks and days before the expiration.
Do you offer a Demo? In the early 90s, trading software was very expensive. I remember paying more than $4000 for my first truly advanced package. It included the ability to create charts and add indicators. Today, many brokerage firm customers have access to similar platforms at no cost. Others charge a monthly fee. Most provide demos and it makes a lot of sense to test drive the trading platform, whether it is software or web-based, before opening an account.
What am I allowed to trade? Before you can begin trading options, your brokerage firm will ask you to submit an options approval form. Based on the information, you will be assigned a trading level. Most firms will allow new investors to trade Level 1 strategies like covered calls and protective puts, but more complex strategies require a greater amount of experience and net worth. If you plan on trading more advanced strategies, find out the firm's stance on options trading approval before you fund the account. You might also ask the firm's policy regarding trading options in Individual Retirement Accounts (IRAs). Some allow options in IRAs. Many don't.
Do you offer portfolio margin? There are two ways brokers can assess margin. The first is the standard margin that has existed for years. The second is the newer portfolio or risk-based margin. The protective put is a popular strategy. It involves buying shares and buying puts. In a typical margin account, the margin is assessed on both the shares (50%) and the cost of the puts (100%). However, the true risk of the position is the price of the shares minus the strike price of the put. The put is a hedge and there is no risk below the strike price of that put. Portfolio or risk-based margin will assess margin based only on this true risk of the position, which in many cases is only a fraction of the typical margin. For investors with substantial trading experience and significant assets, the risk-based margin requirements make a lot more sense. Find out the brokers policy on margin requirements.
Can you teach me options trading? The options industry continues to be one of the fast-growing segments of the financial world. Consequently, many brokerages have ramped up efforts to offer options trading to customers and a big part of that process is education. Many firms offer webinars, live seminars, and education sections on their web sites. When searching for a new options broker, it makes a lot of sense to consider brokerage firms that are committed to helping customers with up-to-date and relevant options education and information.
Frederic Ruffy is an experienced trader and provides daily commentary and analysis of the options market. He is co-founder of the web site, WhatsTrading.com. His work has also appeared in Futures Magazine, Technical Analysis of Stocks & Commodities, Stock Futures and Options, and Sentiment.
In addition to writing market commentary and trading-related books and articles, Fred has also worked as an instructor, educating investors on advanced topics like measuring volatility, the benefits of sector rotation and the risks and potential profits from trading around earnings. An active trader himself, with over 15 years securities industry experience, his market observations and analysis of the options market are featured regularly in the financial press including Barron's, Reuters, The Wall Street Journal, and Bloomberg.
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