As you learned in the Options unit, options are risky, short-term investments. Because of that risk, opening an options account requires extra care and diligence from both the firm and the financial professional.
To see why, consider what could happen if an inexperienced investor is approved for options and then sells a short naked call, which has unlimited risk. If the position moves against them, the account could lose thousands of dollars and the investor could end up in serious debt.
As a financial professional, your role is to help customers understand both the potential benefits and the risks of investing. With options, that means making sure the customer understands the risks before the firm approves the account.
When an investor wants to open an options account, FINRA Rule 2360 requires a specific process:
Let’s break down each step.
The first step in opening any new account is completing a new account form. Today, this is usually done online. The customer provides personal information (name, DOB, SSN, address, etc.) and also provides options-related and suitability-related information, including:
You might wonder why marital status or number of dependents matters for options trading. Many customers have financial obligations to other people. If a customer takes on risky options positions with significant loss potential, those losses can affect not just the customer, but also anyone who depends on them financially. The more obligations a customer has, the more cautious a firm may be when deciding whether to approve an options account.*
Technically, the customer isn’t required to provide the requested suitability information. However, if the customer provides too little information, the firm is more likely to disapprove the account. The approving supervisor (discussed below) uses this information to decide:
Legally, the investor isn’t required to sign the new account form. In practice, most firms require customers to sign a customer agreement, which typically includes an arbitration agreement. We discuss arbitration agreements in a separate chapter.
Once the new account form is completed, it’s sent to a Registered Options Principal (ROP - Series 4) or a General Securities Sales Supervisor (Series 9/10). This supervisor reviews the information and decides whether to approve the account.
If the account is approved, the firm must send the investor a written copy of their background (e.g., investment experience) and financial (e.g., net worth) information within 15 calendar days. This gives the customer a chance to confirm that the information on file is accurate.
FINRA allows this confirmation to be done through negative confirmation (affirmation). That means the customer only needs to respond if the information is incorrect. If the customer doesn’t respond, the firm treats the information as confirmed.
After the new account form is completed, the representative must provide the Options Disclosure Document (ODD). The ODD is a booklet that explains the characteristics, risks, and benefits of options. If you want to see the actual ODD, you can use the link above to download the PDF from the OCC’s website.
The ODD is created by the Options Clearing Corporation. The OCC regulates the structure and activities of the options markets, and part of its role is helping ensure investors have access to clear information about options before trading.
The ODD gives both the OCC and the firm a way to make sure the customer has access to key information. The customer still has to choose to read it, but the resource must be provided.
Delivery of the ODD must occur prior to opening an options account or any options-related discussion. For example, a firm must provide the ODD if it mails options marketing materials to a customer who has not yet received the ODD.
After the new account form is completed, it’s sent to an appropriate supervisor (Series 4 or 9/10) who oversees options-related activity. The supervisor:
The suitability information (e.g., net worth, investment experience, etc.) helps the supervisor decide what securities and strategies are appropriate given the customer’s background and financial situation. Based on that review, the supervisor determines what level of options trading the customer is eligible for.
If a customer lacks experience and/or doesn’t have the necessary financial resources, the supervisor may disapprove the account or limit the customer to lower-risk strategies such as covered calls and/or long options (both have limited loss potential). If a customer has years of investing experience and high income/asset levels, the supervisor may consider allowing riskier strategies like short naked calls (subject to unlimited loss potential).
Once the supervisor determines that the required information has been provided and decides what options activity will be permitted, they sign the new account form (if they approve it). After the form is signed, the account is approved and the customer can place options trades.
Once the account is approved, the customer can place trades. Technically, the account is considered “open” when the first trade is placed. Whether it’s an opening purchase or sale, the account becomes active after the first trade occurs.
During the account-opening process, the representative provides the options agreement to the customer. By signing it, the customer confirms they:
The customer has 15 calendar days from account opening to return the signed options agreement. If it isn’t returned on time, the account is restricted to closing transactions only.
For example, the customer could close out a short put by entering a closing purchase. In other words, the customer can reduce or eliminate existing options positions, but can’t establish new positions (opening transactions) until the signed options agreement is returned.
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