So You Want To Trade Options/Beginners

6 Questions to Ask Before Choosing a Broker

Elizabeth Harrow (eharrow@sir-inc.com)

Selecting a broker isn’t quite as big a deal as choosing a spouse, but it’s definitely not a decision that should be made hastily. After all, this is the person who’s going to be manhandling your investing dollars! Before you surrender your hard-earned cash, some good old-fashioned research is in order. In this article, I’m going to explain the six specific questions you should ask before choosing a broker..

How knowledgeable a trader are you?

In case it’s not obvious, this particular question is one that you need to ask yourself. If you’re a relatively self-aware individual, you should be able to find the answer without doing too much soul-searching. For the sake of simplicity, there are three possible answers: beginner, intermediate, and advanced.

If you’re a beginner. you’re probably still unsure how this whole options trading stuff works. You’re probably favoring very basic strategies, such as long put and call positions. If this is you, you just might want to go with a full-service broker. As the name implies, you’ll get plenty of personalized attention and perks — the firm will likely provide you with an individual broker to handle your accounts, and most will offer in-house investment research services. If you need advice, answers to pressing questions, or simply a bit of hand-holding, full service is the way to go.

The trade-off? Full-service brokers are more expensive than their discount rivals. But, as the saying goes, you usually get what you pay for. As a warning to newbies. though, many full-service brokers work on commission — in other words, they make money every time you make a trade. Ethically challenged brokers might try to take advantage of this set-up by inducing you to trade unnecessarily, so don’t be afraid to trust your own gut instincts over the broker’s recommendations.

Moving on to our intermediate and advanced traders, discount brokers are a viable option. You’re not going to get as much personal attention, and fewer frills will be available. However, you’ll generally pay lower fees and commissions. If you’ve got your bearings in the market and a good sense of trading mechanics, it makes sense to save money where you can by opting for a discount firm.

Deep-discount brokers are also available for those investors who require a bare minimum of service and attention. Think of these firms as the quick and dirty subset of the brokerage world — they’ll get it done for cheap, but they might not answer the phones after 5 p.m.

What fees/expenses are involved?

Now that we’ve finished our navel-gazing session, and we all know what kind of traders we are, we’ve got a good start on our quest for the perfect broker. However, not all full-service firms are alike, and some discount brokers are surprisingly attentive. Let’s narrow the field, shall we?

Once you’ve located a possible candidate to serve your option-trading needs, you need to figure out how much money they’re going to try and wring out of you. How much will it cost to place an order? Is that a sliding scale based on the size of the trade, or a flat rate? What are the fees for maintaining an account? Will an inactivity fee be charged if the account remains idle for a certain period of time? Do additional services bring with them additional expense?

These questions should give you a healthy start on determining how costly your options trading habit will be. And, call me a cynic, but you might want to get that pricing information in writing before you open an account.

What are the margin requirements?

Along those same lines, you need to determine your broker’s margin requirements. These can include your initial margin, as well as maintenance margins. In short: how much money must I have in my account before I begin trading, and how much additional capital do I need to deposit before executing specific option strategies?

For very basic trades, you might not need to fork over any cash to a margin account. As long as the initial premium is paid in full, your initial margin should be sufficient. However, strategies that involve the sale of an option can require that you deposit 10% to 20% of your total dollars at risk in a margin account. That’s just a general guideline, though — make sure you discuss this with your broker to find out exactly how margin requirements are calculated.

What is the broker’s reputation?

Word-of-mouth still counts for quite a bit, and not for nothing. Before you select a broker, do some digging around to find out the firm’s reputation. Don’t be scared to solicit reviews from friends, colleagues, and relatives. Are they satisfied with the service they receive, or have they had major issues? Were there any surprises once they started trading, or did everything proceed as expected? These word-on-the-Street reviews can reveal whether or not brokerage firms live up to their promises.

How much hands-on service will you receive?

Obviously, the answer to this question will be affected by what type of broker you select (full service or discount). However, not all full-service brokers are created equal, and the same goes for discount firms. Get the details before you commit — can you call at 8:00 p.m. looking for an answer to your trading questions? Will you receive investment recommendations tailored to your needs, or will you simply receive the same research notes as the broker’s other clients? If there’s any specific service you especially require, this is the time to find out whether the firm can meet your needs.

Does the broker have options expertise?

This question is a doozy. If you’re trading options — and particularly if you’re just starting to trade options — it’s definitely in your best interest to work with a broker who understands the special features and quirks of these derivatives. Happily, it’s much easier now than it was 20 years ago to find brokers who cater specifically to option traders.

Of course, anybody can say, Oh, yeah, I’m a total options expert. (This is especially true when the person in question is trying to win your business.) Ideally, you want to locate a firm with Registered Options Principals (ROPS) on the payroll. These options specialists must pass the Series 4 test to prove their knowledge. Check your broker’s credentials to be sure they have the expertise required to handle all your options-trading needs.

And, hopefully, you’re now fully prepared to seek out your ideal brokerage firm. It may take a while to do the research, but — as anyone who’s had a bad brokerage experience can attest — you won’t regret investing your time.