Ready to jump into trading options?
A few crossroads await you: which trading platform to use and what kind of account to open, a cash account or a margin account.
Instead of getting buried in research rabbit holes, you can be up and running in no time, and without rookie blunders.
Intrigued?
Keep reading to learn about the two main brokerage accounts – cash vs. margin – and figure out which one will be your investing wingman with our Cash vs. Margin Account Beginner's Guide below.
Which Brokerage Should You Choose?
You can quickly get bogged down when looking for the best online brokerage for beginners. Options trading beginners often fret over this decision, worrying that the wrong choice will lead to financial ruin.
The good news is that the brokerage you choose is not likely to impact your results much. Most of the top online brokers provide similar services.
Personally, I have used E*Trade for a long time and prefer their Android App (the Power E*Trade App).
Over the years, I have been able to negotiate commissions down to $0 commission and 10 cents per contract.
Other online stock brokers, including Tastytrade, Schwab, Fidelity, TD and Interactive Brokers work very well for beginner traders, too.
What is a Margin Account?
Once you decide on your brokerage, you have to choose an account type. With a margin account, you can borrow money against your account investments.
You have greater purchasing power with a margin account because you are able to trade using more leverage. While a margin account can provide greater profit potential, there are more risks when using this type of account.
Any losses are multiplied when stocks are purchased on margin, and you may be subject to a margin call.
Margin Account Requirements
A margin account does not provide you with unlimited purchasing power. You are still limited by the net liquidation value, or account size, of your margin account.
Currently, the Regulation T margin reduces your buying power by 50%, or half, for a stock purchase.
When trading options, the margin requirements when using Regulation T are about 20% of the maximum loss.
If you sell a put option with a strike price of $100, then each contract you sell will reduce your buying power by approximately $2,000 (100 shares * $100 * 20%).
Margin Account Example
If you have a margin account with $20,000, you can purchase up to $40,000 of stock.
Your overall purchasing power is doubled with a margin account, but you also will pay margin interest on this purchase.
Do I have to Use Margin in a Margin Account?
While you can margin up to 50% of your stock purchase, you do not have to. Your margin account enables you to borrow any amount up to 50% of the stock purchase. For example, you can margin up to 10% or 30% if you prefer.
What is a Cash Account?
If you use a cash account, you have to make all transactions with your available cash. To buy securities, you have to deposit cash in order to settle the trade. You can also sell existing positions and use the proceeds to settle your order.
Cash accounts are more straightforward than margin accounts and they carry less risk. There is also no margin interest charged when using a cash account.
If you want to use the best options trading strategy, you can trade both a margin and a cash account – although margin requirements for stocks are different than the requirements for options.
Cash Account Day Trading
Some options traders with a cash account consider day trading options.
I do not recommend this because if you day trade options then you will not have an opportunity to profit from theta decay.
Here at BestStockStrategy, I offer a way to balance theta decay with high probability trades so that you can earn money by trading options.
Margin Requirements When Trading Options
When selling options, you can use Regulation T margin or Portfolio Margin.
Regulation T margin typically reduces your buying power by approximately 12% - 20% of the maximum loss when selling options. Your buying power is reduced by the width of the strikes, less the credit received, when selling vertical credit spreads.
When using Portfolio Margin (for accounts of $100,000+ with most brokers), the risk of your entire portfolio is taken into account.
In general, with portfolio margin, traders realize about 3x – 5x more buying power efficient than with Regulation T. For example, if selling a put reduces your buying power by ~$10,000 using Regulation T, then it'll likely reduce your buying power by about $2,000 - $3,000 with Portfolio Margin.
Additionally, traders who sell options do NOT pay interest on their margin loans when using Portfolio Margin.
Portfolio Margin basically provides free leverage. And you can also go long stock AND leverage off that stock to trade options when using portfolio margin.
Do You Need a Large Cash Account?
I can teach you how to trade with a smaller cash account.
You do not have to start with a large cash account in order to be successful options trading.
Reviews of David Jaffee and BestStockStrategy.com show that students are able to increase their account, even if they start with a smaller initial investment.
Learn more about how to make the most of your cash account by enrolling in my online options trading course.
Cash Account vs. Margin Account: Which To Choose?
In general, it's best to trade with a Regulation T margin account if you don't qualify for Portfolio Margin. And then use a Portfolio Margin account if you qualify.
Just because you have Regulation T, or Portfolio Margin, enabled does not mean that you have to use it. You can trade spreads and mimic a cash account to reduce risk regardless of the margin type you use.
Frequently Asked Questions (FAQs)
What is the main difference between a cash and margin account?
The main difference between a cash account and a margin account with a brokerage is that a margin account allows you to borrow money to fund your investments, while a cash account only lets you use the money you already have in your account.
Which is better cash account or margin account?
Margin exposes you to a higher risk of bigger losses. It also allows you to earn more from the gains. Cash accounts, on the other hand, limit you to investing the cash you have on hand. You don't have to worry about margin calls, but your gains are limited to the amount you're able to invest.
Are margin accounts a good idea?
Margin trading is risky since the margin loan needs to be repaid to the broker regardless of whether the investment has a gain or loss. Buying on margin can magnify gains, but leverage can also increase losses and lead to margin calls.
Is a margin account good for beginners?
If your goal is to sell options and collect option premium, then you will likely need a margin account because the buying power reduction when selling naked options is simply too high if you're not using margin and the ROI (premium collected vs. capital at-risk) will be too low if you're not using margin.
Alternatively, traders can use vertical credit spreads though to mitigate the large buying power reduction.
When trading spreads, beginner traders have defined, and limited, risk.
Are there different types of margin accounts?
Yes, there is Regulation T, SPAN margin and Portfolio Margin.
Portfolio Margin and SPAN margin are very similar (SPAN margin is for futures trading).
Portfolio margin evaluates the liquidity and risk profile of your entire portfolio.
In general, I believe it's best to use Portfolio Margin (if your broker offers it).
Can I switch from a cash account to a margin trading account?
Yes, you should be able to easily switch to a margin trading account by contacting your online brokerage.