Account opening process

As you’ve learned, options are risky short-term securities. Due to the risk involved, opening an options account requires the registered representative and firm to take extra care and exercise sound judgment. Think about it - imagine you help an inexperienced investor open an options account, and then they sell a short naked call with unlimited risk. Later, the account loses immense value, and the investor goes deep into debt. How would you feel?

Registered representatives must help customers understand the benefits and risks of investing in options, which is accomplished through the account opening process. FINRA Rule 2360 requires the following protocols to be followed when an options account is opened:

1. Customer completes a new account form
2. The ODD is delivered
3. An options principal approves the account
4. First trade “opens” the account
5. Customer returns signed options agreement within 15 days

Let’s break down each step individually:

Customer completes a new account form

The first step to opening any new account requires an account form to be completed (filled out). In today’s digital age, virtually all account forms are completed online. The customer discloses their personal information (name, DOB, SSN, address, etc.), plus some options-related suitability-related items, including:

• Investment objective
• Employment status
• Estimated annual income
• Estimated net worth
• Estimated liquid (easy to access) net worth
• Marital status*
• Number of dependents*
• Investment experience and knowledge

*You might wonder how marital status or the number of dependents relates to options trading. It’s not uncommon for an investor to support their family financially in one way or another. If they were to enter into risky option contracts that subjected them to significant loss potential, the situation would be much worse if dependents were involved. The more family obligations a customer has, the more restrictive a brokerage firm should be when deciding whether or not to approve an options account.

The customer is not technically required to answer suitability questions, but is at a higher risk of their account being disapproved. This information is used by the approving supervisor (discussed below) to determine if the account should be approved and what type of options contracts can be traded by the customer (if approved). Would it be a good idea to allow a novice to enter into an option contract that could result in them losing a significant amount of money? No! That’s why this rule is in place.

Technically speaking, the investor is not required to sign the new account form. In practice, most financial firms mandate a signature on some form of a customer agreement, which typically includes an arbitration agreement and other requirements to remain a customer of the firm. In a future chapter, we’ll discuss arbitration agreements.

Once the new account form is completed, it’s forwarded to a Registered Options Principal (ROP - Series 4) or General Securities Sales Supervisor (Series 9/10), who analyzes the information provided and determines if the account should be approved. Should the account be approved, the firm must send the investor a summarization of their background and financial information (e.g., investment experience/knowledge, net worth) within 15 calendar days. This process allows the customer to affirm the documentation on file is correct. This type of affirmation is performed by negative confirmation (affirmation), which means the investor only needs to respond if the information on file is incorrect. If the customer does not respond, the firm assumes the details on file are correct.

The ODD is delivered

After the new account form is completed, it’s the registered representative’s responsibility to provide the Options Disclosure Document (ODD), which is an options booklet of characteristics, risks, and benefits of options. If you want to see the real ODD, click the link above and download the linked PDF.

The ODD is a creation of the Options Clearing Corporation (OCC), which we learned about earlier. Securities regulators want to ensure investors understand options before they trade them (as much as possible). The ODD provides an opportunity to verify an investor has enough access to information on options. While the investor must choose to spend the time reading the booklet, the resource is available.

The ODD must be delivered to each customer at or prior to account approval. Any amendments made to the ODD must be delivered to existing customers by the time an options transaction related to the amendment is confirmed. For example, assume the ODD’s section on spread strategies is updated. By the time an existing customer’s spread trade is confirmed (by trade confirmation*), they must receive the relevant ODD amendment(s).

*A trade confirmation is an official document summarizing a securities transaction’s aspects, costs, and results. This document is discussed further in the brokerage accounts unit.

Options principal approves account

After the new account form is completed, it’s forwarded to an appropriate securities principal/supervisor (Series 4 or 9/10) with oversight concerning options-related activities. The supervisor confirms the customer provided all legally required information on the new account form and determines the suitability of the account.

The requested suitability information (e.g., net worth, investment experience) helps the principal determine what securities and actions are appropriate for the customer given their background and financial situation. With this information, the principal will determine what level of options trading the investor is eligible for.

Suppose an investor lacks investing experience or doesn’t have financial resources. In that case, the supervisor may disapprove the account, or only allow investments in covered calls and/or long options (both have limited loss potential). On the other hand, suppose an investor has years of investing experience and significant financial resources. In this case, the supervisor may consider allowing riskier option strategies like short naked calls or short straddles (both have unlimited loss potential).

When the principal concludes the required information has been disclosed and determines the level of options that can be traded, they sign the new account form (if they decide to approve it). Once signed, the account is officially approved, and the investor can perform options transactions.

First trade “opens” the account

Once the account is approved, the customer can place trades. Technically, the account is “opened” once the first trade is placed. Whether it’s an opening purchase or sale, the account is officially active after the first trade is placed.

Customer returns signed options agreement within 15 days

At some point during the account opening process, the financial representative delivers the options agreement to the customer. This agreement, if signed, confirms the investor has been provided the ODD, plus understands and will abide by the rules of the market (created by the OCC), which include complying with position and exercise limits (discussed later in this unit).

The customer has 15 calendar days from account approval to return the signed options agreement. If they do not return it in time, the account will be restricted to closing transactions only. For example, the customer can close out a short put by performing a closing purchase. Essentially, they can liquidate current option positions, but can’t establish any new positions (opening transactions) until the options agreement is signed and returned.