A:

In the United States, all options contracts go through one of several options exchanges. An investor must have an account with a brokerage firm that provides options trading as part of its product offerings. As a brokerage customer, your options orders will be routed through the brokerage firm to one of the options exchanges. Depending on the broker, you may be able to "route" your order to send it to a particular exchange, or the brokerage firm will use a standardized method for selecting the exchange to carry out the order.

Before you can trade options, your broker will approve you for a specific level of options trading. You will have to fill out an options agreement form that is used to evaluate your understanding of options and trading strategies and your general investing experience. Generally, brokerages have four or five levels of approval that are based on factors such as your investing objectives, investing history and your account balance.

Your options trading level, such as "conservative" or "aggressive," will determine the types of options strategies you will be able to trade. Since some strategies involve substantial risk, you may or may not be allowed to employ these riskier strategies, depending on your trading level. Typically, traders with more experience and more liquid assets are given higher approval levels; conversely, those with less experience and smaller accounts are given more conservative approval levels.

Once you have an account and have been approved for options trading, you can use the broker's trading platform to scan for positions that match your market outlook or strategy and to submit orders. Alternatively, you can phone in orders by calling the broker's trade desk.

There are other ways to trade options but they are not as common as routing orders through a broker. Over-the-counter (OTC) options are not traded via an exchange; instead, these contracts are executed between two independent parties. Since OTC options are not traded on exchanges, counter-party risk is not limited by the Options Clearing Corporation (OCC) as it is with exchange-traded options. Typically, only institutional traders or investors with large amounts of capital trade OTC options because of this increased financial risk. Well-capitalized professionals can also become members of one of the exchanges to place trades directly.

RELATED FAQS

  1. How does a forward contract differ from a call option?

    Find out more about forward contracts, call options, the mechanics of these financial instruments and the difference between ...
  2. What are common delta hedging strategies?

    Learn about common delta hedging strategies, including how to make a position in options delta neutral by offsetting risk ...
  3. How do I determine the breakeven point for a short put?

    Learn how to determine the breakeven point for a short put. Shorting puts is appropriate for sophisticated traders who understand ...
  4. What options strategies are best suited for investing in the retail sector?

    Learn how savvy investors employ options strategies such as the long straddle and long strangle to profit from the volatile ...
RELATED TERMS
  1. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  2. Strike Width

    The difference between the strike price of an option and the ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  4. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  5. Boundary Conditions

    The maximum and minimum values used to indicate where the price ...
  6. Delta-Gamma Hedging

    An options hedging strategy that combines a delta hedge and a ...

You May Also Like

Related Articles
  1. Investing Basics

    How To Create Capital Protected Investment ...

  2. Options & Futures

    How does a forward contract differ from ...

  3. Options & Futures

    Tesla Stock Too Expensive? Trade Tesla ...

  4. Options & Futures

    Stock Options To Trade On Intraday Momentum ...

  5. Mutual Funds & ETFs

    4 Ways You Can Invest In Gold Without ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!