Josip Causic

Option Approval Levels Explained

    Tweet This

Option level approval is a commonly overlooked area of option trading. When a person opens an account, the broker assigns them one of several option approval levels supposedly based on the option trader's knowledge and needs.

In many instances, the students in the Options Trader courses I have recently taught did not know what level of approval they had, and a few students were unaware that the levels even existed.

I suggest that anyone who is uncertain of their option approval level contact his or her broker to find out which level of option approval their account has. It is possible to fill out additional paperwork and to have the level of approval bumped up. However, it does to take time to do it. Faxing the paperwork might expedite the process a bit.

Usually there are four option approval levels, generally ranked from one to four, the highest rank being the highest level of approval. The higher levels allow the trading of the strategies listed in the lower levels. For instance, Level 3 allows not only for spread trading, but also for going long on calls and puts which were included in Level 2. Thus, each level is cumulative.

At any rate, there is no official standard of what strategies could be traded at which level. The table below presents universal industry guidelines in terms of strategies commonly associated with each level. I have also added another column for abbreviation. I usually mark a long position with a plus in parentheses, while for a short position I use a minus sign. Calls are marked by "c" and puts by "p".

Level 1

At the first level, an option trader is permitted to do covered calls, as well as "long protective puts." Now there is a catch to it; at this level a trader is not allow to buy any calls, but is allowed to buy puts only in the amounts he or she holds, and also only on the specific stock that he or she owns.

For instance, if a trader owns 100 shares of a stock, then they could purchase a single put contract and nothing more. By the way, this is generally the only level that most brokerages will approve for IRAs (individual retirement accounts).