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Why Online Option Brokerage Selection Is Critical for Options Traders

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The demands of an options trader from his broker are far more robust than those of the stock trader.

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My previous ruminations have dealt with some of the basic concepts of options pricing, and I have introduced several of the families of options trades with which we will become more familiar in the future as we discuss specific trades.

Another necessary discussion is that of choosing an "options-friendly" broker. Although no broker would admit to being "option-unfriendly," certain policies and operational concerns readily identify the brokers most receptive to the unique demands and needs of active options traders.

Options trading volumes are exploding as more and more traders begin to recognize the inherent advantages of an options-based approach to trading. The advent of weekly options has dramatically accelerated this realization as traders come to understand the unique advantages of the fast tempo of these unique products.

As a result, brokers have been attempting to define themselves as being friendly to options products. It takes more than hopeful statements, and only a handful of brokers have all the functional characteristics needed to help you on the journey to becoming a successful options trader.

The demands of an options trader from his broker are far more robust than those of the stock trader. Necessary data are far more voluminous and require dramatically more discrete pieces of information than those necessary to support the stock trader.

Consider, for example, the various options series currently available to trade in Apple (AAPL); the individual strikes and monthly series together represent approximately 600 individual options. This does not include the available weekly options or longer-term options, designated as LEAPS.

In order for the trader to have the information needed to analyze and compare individual potential trades, he must have available at a minimum the following data points for each of the options in which he is considering a trade: bid, ask, volume, open interest, and implied volatility. Brokers with less than state-of-the-art data handling capabilities burden the trader with an unacceptable competitive disadvantage.

Another important consideration is the ease of use of the platform. As skill grows with options trades, trades often become more complex and consist of several legs. It is important to evaluate critically the ease of use of an individual broker's platform and order entry system.

As an example, it is essential to be able to enter multilegged options trades such as the four-legged iron condor as a single order rather than several individual orders. Many broker platforms allow the entry of such orders with a minimal number of key strokes.

While selection of an easy-to-use platform is important to keep typing and time for order entry under control, there is also a subtle but important corollary to ease of use. Many platforms contain a pre-populated strategy dependent order entry boxes that allow entry of appropriate legs of an options trade and do not allow illogical entries. It is stunningly easy to make errors of both omission and commission when entering options orders for execution.

A word is in order about commission rates. These rates are important and represent a significant drag on your ability to produce consistent trading profits. Many traders focus exclusively on finding the broker with the least expensive commissions. However, a rock-bottom commission rate does not represent the single factor by which to select the most appropriate broker to use.

Other factors essential to success include an easy-to-use analytic platform that allows the trader to model trades prior to execution, a user-friendly order entry platform that helps minimize errors, and the ability to get trades executed at reasonable prices. Focusing exclusively on commission rates is being "penny wise and pound foolish."

It is important to be aware of another group of two factors that are less obvious when making your broker selection -- the availability of futures and the ability to qualify for and use portfolio margin. I believe it is important to have the ability to trade not only options and the various underlyings from which they derive but also futures. Not all brokers offer this useful product.

Finally, the ability to use portfolio margin is essential for the experienced trader. Many traders confuse portfolio margin with normal margin as would routinely be used in a stock trading account; this routinely encountered type of margin is generally referred to as "Reg T Account or Reg T Margin."

This recently approved calculation of margin requirements is not the same animal as the long-standing Reg T margin. Portfolio margin is a risk-based margin requirement based on an assessment of risk evaluated against the entirety of the trader's portfolio. Portfolio margin brings for the options trader the much more reasoned and logical approach to margin requirements previously only encountered in the world of futures.

Portfolio margin recognizes and accepts the dynamic nature of risk to which an options trader is exposed and largely replaces the fundamentally flawed risk logic previously enforced by the outmoded regulations of the Securities and Exchange Commission. Portfolio margin is a great tool for the more experienced trader to maximize the efficiency of his capital.

Selection of a broker is not a one-size-fits-all scenario. The large number of individual brokers available for use in help with trading options in the modern world results in a close fit for an options trader's specific needs.

Editor's Note: JW Jones offers more content at OptionsTradingSignals.com.

For more on options trading, take a 14 day FREE trial to OptionSmith. Get access to veteran options trader Steve Smith's portfolio along with emailed alerts and strategy with every trade he makes. Learn more.
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No positions in stocks mentioned.
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