Options Approval Levels in Trading: A Definitive Guide

Understanding options approval levels is crucial for any trader looking to navigate the complexities of option trading. Each level unlocks different strategies and potential risks, which can significantly impact your trading performance. This guide will walk you through the various levels, what they entail, and how to get approved for them.

Read this article because it offers a comprehensive guide on understanding and qualifying for options approval levels, crucial for unlocking complex trading strategies…

I’ll answer the following questions:

1. What are the different levels of options approval in trading?
2. How do covered calls and cash-secured puts work at level 1?
3. What strategies can I use at level 2 with long options?
4. What are the benefits and risks of trading option spreads at level 3?
5. Why is level 4 considered the riskiest options trading level?
6. How do brokers determine your options trading level?
7. What is required to get approved for options trading?
8. How should I choose the right options trading level for myself?

Let’s get to the content!

General Option Trading Levels

Option trading levels are tiers assigned by brokers that dictate the types of option strategies you can use. These levels are designed to protect both the trader and the broker by ensuring that traders engage in strategies appropriate to their experience and risk tolerance. Typically, there are four levels, each allowing progressively more complex and potentially riskier trades.

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Level 1 – Covered Calls & Cash-Secured Puts

Level 1 approval allows you to trade covered calls and cash-secured puts. Covered calls involve holding the underlying stock while selling call options against it, generating additional income from the premiums. Cash-secured puts require you to hold enough cash in your account to buy the stock if the put is exercised. These strategies are considered relatively safe as they involve owning the underlying asset or having sufficient funds to cover the potential purchase.

Covered Calls

• Involves holding the underlying stock while selling call options against it.
• Generates additional income from the premiums.
• Suitable for conservative investors seeking steady income.

Cash-Secured Puts

• Requires holding enough cash in your trading account to buy the stock if the put is exercised.
• A way to purchase stocks at a desired price while earning premiums.
• Considered a safe strategy with limited risk due to cash reserves.

There’s a reason all beginners start here, and it’s because they’ve still got to do this…

Level 2 – Long Options

At Level 2, you can start trading long options, which include buying calls and puts. This level introduces more risk as it involves the potential for significant price movement in the underlying securities. However, it also offers greater potential rewards. Long calls give you the right to buy a stock at a predetermined price, while long puts give you the right to sell. These options are valuable tools for traders looking to speculate on market movements or hedge existing positions.

Long Calls

• Gives the right to buy a stock at a predetermined price.
• Used to speculate on upward market movements.
• Offers potentially high returns with controlled risk.

Long Puts

• Grants the right to sell a stock at a specific price.
• Useful for hedging against downward market movements.
• Can protect the value of existing holdings in your brokerage account.

Level 3 – Option Spreads

Level 3 approval unlocks the ability to trade option spreads, which are strategies that involve multiple option positions. Common spreads include vertical spreads, where you buy and sell options of the same type with different strike prices, and calendar spreads, which involve options with different expiration dates. These strategies can limit risk compared to outright long options and offer more controlled profit scenarios. Spreads can be complex, requiring a good understanding of market behavior and option pricing.

Vertical Spreads

• Involves buying and selling options of the same type with different strike prices.
• Limits both potential profit and risk.
• A common strategy among more experienced traders.

Calendar Spreads

• Entails options with different expiration dates.
• Allows traders to benefit from time decay differences.
• Requires an understanding of market behavior and option pricing.

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The Trade Volume Index (TVI) is a powerful tool for traders looking to identify buying and selling pressure within a market. Unlike traditional volume indicators, the TVI accounts for intraday price movements and helps distinguish between accumulating and distributing phases. Integrating the TVI into your trading strategy can enhance your ability to spot potential reversals and trend continuations. By monitoring the TVI alongside other indicators, traders can achieve a more nuanced understanding of market sentiment. For a detailed exploration of how to use the TVI effectively, check out this guide on using the Trade Volume Index.

Level 4 – Naked Calls & Puts

Level 4 is the highest and riskiest level of options trading. It allows for trading naked calls and puts, where you sell options without owning the underlying asset or having sufficient funds to cover the potential position. This strategy carries unlimited risk, especially with naked calls, as losses can exceed the initial investment. Traders at this level must have extensive experience and a strong understanding of margin requirements and market dynamics.

Naked Calls

• Selling call options without owning the underlying asset.
• Carries unlimited risk as losses can exceed the initial investment.
• Suitable only for highly experienced investors with substantial knowledge of margin accounts.

Naked Puts

• Selling put options without holding sufficient funds to buy the stock if exercised.
• Significant risk if the stock price drops drastically.
• Requires extensive experience and risk management skills.

You’ll need to understand market trends to effectively trade advanced options strategies. An often-overlooked phenomenon is the occurrence of high trading volume without significant price movement. This can indicate market indecision or the presence of institutional trading strategies that absorb liquidity without affecting price. 

Check out my article on high volume with no price movement to learn more!

How Are Trading Levels Assigned?

Brokers assign trading levels based on several factors, including your trading experience, financial situation, and knowledge of options. During the application process, you’ll provide information about your investment objectives, income, net worth, and trading history. This data helps brokers assess your ability to handle the risks associated with different option strategies. They use this assessment to determine the appropriate level for your account, ensuring you are not taking on more risk than you can manage.

Your broker is the most important of this equation — make sure you’re looking for the right things:

What Is Required to Get Options Trading Approval?

To get approved for options trading, you need to complete an options trading application with your broker. This application will ask for detailed information about your financial status, investment experience, and knowledge of options. Brokers look for a combination of sufficient capital, appropriate risk tolerance, and a solid understanding of option strategies. In some cases, they might require a margin account, especially for higher trading levels. Approval is not guaranteed and will depend on how well your profile matches the requirements for the desired trading level.

How to Choose the Right Level

Choosing the right options trading level depends on your experience, financial situation, and risk tolerance. 

Pay attention to this part…

Beginners should start with Level 1, focusing on covered calls and cash-secured puts. As you gain more experience and confidence, you can apply for higher levels, exploring long options and spreads. It’s essential to evaluate your trading goals and ensure you understand the potential risks and rewards of each level. Consulting with a knowledgeable broker or financial advisor can also help you make an informed decision.

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Overnight trading strategies offer unique opportunities for traders to capitalize on after-hours market movements. These strategies involve holding positions overnight to benefit from news releases, earnings reports, and other events that can impact stock prices. Properly executed, overnight trades can yield significant returns and complement intraday trading tactics. However, it’s essential to understand the risks and market behavior during these hours to avoid unexpected losses. Check out my in-depth guide here.

Key Takeaways

• Option approval levels ensure traders use strategies suitable for their experience and risk tolerance.
• Choosing the right level depends on assessing your financial situation and knowledge.
• Successful trading requires continuous education and leveraging brokerage tools and services.

There are a ton of ways to build day trading careers… But all of them start with the basics.

Before you even think about becoming profitable, you’ll need to build a solid foundation. That’s what I help my students do every day — scanning the market, outlining trading plans, and answering any questions that come up.

You can check out the NO-COST webinar here for a closer look at how profitable traders go about preparing for the trading day!

What options level are you certified for? Write “I won’t trade without a plan” in the comments if you’re ready to trade the right way!

Frequently Asked Questions

Is Options Trading Better Than Buying Stocks?

Options trading offers different opportunities and risks compared to buying stocks. It allows for leveraging positions, hedging, and generating income through various strategies. However, it also involves more complexity and potential for loss. Whether it is better depends on your trading goals, risk tolerance, and experience. Stocks offer straightforward ownership, while options provide flexibility and multiple ways to profit from market movements.

What Can I Do With Level 2 Options?

With Level 2 options approval, you can buy calls and puts. This level allows you to speculate on market movements or hedge existing positions. Buying calls gives you the right to purchase a stock at a specific price, while buying puts gives you the right to sell. These strategies can be profitable but carry the risk of losing the entire premium paid for the options.

What Is the Highest Level of Options?

The highest level of options trading is Level 4, which permits trading naked calls and puts. This level carries significant risk as it involves selling options without owning the underlying asset or having sufficient funds to cover potential losses. Traders at this level need extensive experience, knowledge of margin accounts, and a strong understanding of market dynamics.

How Do Option Approval Levels Impact My Trading Options?

Option approval levels determine which trading strategies you can employ based on your experience and financial situation. These levels act as safeguards, ensuring that investors only engage in strategies that match their risk tolerance and trading knowledge. Your brokerage account will be assigned a level that dictates the types of trades you can execute, from basic covered calls to more complex naked options.

What Are the Restrictions for Each Trading Level?

Each trading level comes with its own set of restrictions designed to protect investors from excessive risk. For example, Level 1 limits you to covered calls and cash-secured puts, which have lower risk characteristics. As you advance to higher levels, such as Level 3 and Level 4, you gain access to more complex options strategies but also face stricter requirements, such as maintaining a margin account.

What Rights and Trade Options Do Different Brokerage Accounts Offer Their Customers?

Brokers like TradeStation, E-Trade, Interactive Brokers, etc., offer a range of products and services that cater to different trading levels, providing tools to enhance your trading results. As a member, you can leverage their advanced trading platforms, educational resources, and customer support to refine your trading strategy. These services are designed to support traders at every level, from beginners to experienced investors, ensuring that everyone has the resources they need to succeed.