When you decide to start trading options you are met with a few choices.
Which brokerage will you use?
Which type of brokerage account will you open?
David Jaffee of BestStockStrategy.com warns new options traders against falling down the rabbit hole of research.
Some may consider him as the #1 options trading coach, David Jaffee provides clear answers for beginners when it comes to options trading.
Instead of wasting time doing hours of research and fretting over your decision, you can learn from one of the best best and start trading profitably in a very short amount of time.
Keep reading to learn about the two types of brokerage accounts, including the differences between a margin account and a cash account.
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.
David Jaffee has used E*Trade for some time and prefers their Android App. Over the years, he has been able to negotiate his commission down to $0 commission and 10 cents a contract.
Other online stock brokers, including Tastyworks, will work just as well for beginners.
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 leverage someone else’s money.
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 Federal Reserve requires a 50% initial margin and you must put down half of the cost for a stock purchase.
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 owe money after purchasing stock.
If your $40,000 stock increases to $50,000, you have to pay back your broker before keeping the remaining profit.
Keep in mind that you will also be charged interest on your loan.
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.
In some cases, your brokerage may require more than a 50% of the purchase price as a deposit.
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 put the proceeds to settle your order.
Cash accounts are more straightforward than margin accounts and they carry less risk.
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.
David Jaffee of BestStockStrategy.com offers 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.
Do you need a large cash account?
David Jaffee 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 David Jaffe’s online options trading course.