Can I invest in options?
Will most brokerage firms allow for an individual to invest in options? If so, should I have a margin to back these up or have a special account?
Yes most brokerage firms allow for an individual to invest in options. Robinhood is a good option as well as a free trading platform, and they recently added options as well. The downside is that they do not currently offer IRA accounts so everything is done in a taxable account.
When it comes to the options themselves, you can sell covered calls, buy call options or buy put options without needing a margin account. If you are interested in selling naked call options (meaning you don't own the stock) or selling put options then you will likely need a margin account (selling put options does not always require margin if you keep enough cash available, but that might mean holding more cash than you're comfortable with).
As I have used options through the years I have seen some good uses so I will illustrate those here as food for thought:
- Initiate a new position by selling puts. Let's say you want to buy shares in Facebook, but Facebook stock is currently trading around $180/share. You are willing to pay that much for 100 shares, but you are worried about potential short-term volatility. Instead of paying $180/share you have the option of selling one put contract at a strike price of $165/share that expires Feb 16, 2018. In selling this contract you will receive $200 in premium from the buyer. Scenario 1: February 16th rolls around and Facebook is about to close at $160/share. Your put is out of the money and you'll be force to buy the stock at $165/share which is an extra $500 in cash you'll have to fork out over the current market price for 100 shares. Remember that you received $200 in premium for your option so really you're out $300. Also remember, you were willing to spend $180/share because you like the long-term prospects of the company. Now you bought it for $165/share so you really helped yourself. Scenario 2: February 16th rolls around and Facebook is about to close at $190/share. The stock went higher, you are not forced to buy the stock, and you can pocket the $200 in premium you received. However, you still don't have the stock you want. Because of this reason, many investors will sell puts to identify the price they are willing to spend on a stock, but also use some of that premium to buy calls in case the stock moves higher.
- Buy Long-Term Call Options (aka Leaps). Right after a stock gets beaten up and drops 20% or more it may be tempting to initiate a new position. Traders call these stocks value traps, because they look like they have dropped enough to become a good value for new purchases. Let's say a stock is trading at $15/share, and you like the prospects of a turnaround, but you realize it will likely take some time. Many turnarounds don't start really paying off for 12 - 18 months. You can buy 300 shares of this stock at $15/share, but that will require $4,500 in money and you don't expect to see much of a return soon. Or you could buy a call option either at the money ($15/share strike price) or out of the money (maybe $18 or $20 strike price) with an expiration of January 2019 (or as far as you can go). You can buy 3 call options at $500 (arbitrary number) in premium, and if the price appreciations you have the option of buying the actual shares. If the stock doesn't turnaround you only had $500 at risk instead of the full $4,500, and instead of locking in $4,500 of your capital you only locked in $500 and left the extra $4,000 to invest in something else.
I understand that was a really long way of answering your question, but hopefully you found the extra information helpful.
Good luck to you!
Yes, most brokerage firms allow individuals to trade options. You will have to fill out a document which will ask a few questions about your background, income etc. based on which most brokerage firms will approve you for a level of options trading (there are 4-5 levels usually) You do not necessarily have to have margin for lower levels but do need a margin account for higher levels which correspond to more risky strategies (such as writing uncovered options). Also, keep in mind if you write options and it moves against you, you will get a margin call if your account does not have sufficient margin.
You are asking a good question. You don't need a special account, you just need authorization from the broker. Usually this means answering questions about your background with options, and your financial situation. It is a good idea to have extra cash as a backup in the event the trades don't go well, so that is a good idea. Options are expecially useful in hedging existing positions, or what is called risk management. I wish you success with your options future, and I hope I helped answer your question.
Yale Bock, CFA
Y H & C Investments