You’ve come to the part of your day trading journey where you’re wondering which account type is best for day trading options. As with all things trading, the real answer is: it depends.
So we’re on the same page, day trading options is the same as day trading stocks or any other equity. You buy calls or puts and close out the transaction before the end of trading at 4pm EST. For the sake of simplicity, we’re only focusing on regular trading hours, ignoring the premarket and after hours sessions.
Depending on what your goals for trading are, there may be a benefit for one type of account over another. Let’s go over each type to determine a perfect fit.
According to the SEC a margin account is type of brokerage account in which your broker-dealer lends you cash, using the account as collateral, to purchase securities. In other words, your broker lets you buy more than you can afford, and uses your initial cash as a back up in case you lose money.
For most brokers, a margin account is the default option when you fill out your application. Often beginner traders don’t know the difference and aren’t aware there is another account option to choose from.
Many online trading platforms will let you open an account with no deposit or a very small one. This is helpful when you are trying to paper trade to get familiar with a setup or the trading platform itself. FINRA, however requires you to deposit a minimum of $2,000 before you can make any trade on margin. Some firms may even request you deposit more.
Understand that you may have opened a margin account by default, but you won’t have access to any margin features until you have a $2,000 balance. On top of that you’ll also be subject to the Pattern Day Trader or PDT rule.
In short the PDT rule says you can’t make more than 3 day trades in any 5 trading day period. If you want to make more day trades than that, you will need a margin account with at least $25,000 in it.
Options and Margin
What do you need to be aware of to day trade options with a margin account? Unlike with stocks, you can’t use margin to buy more options than you have cash for. With a margin account you might be able to buy $1,000 worth of stock with only $500. That same $500 will only buy the contracts you can afford.
Another feature of trading options in a margin account is that you won’t have to wait for the trade to settle to use those funds. If you bought $400 worth of options and sold them for a profit of $100, you can use that $500 immediately for another trade.
Pros and Cons of Margin Accounts
Every great strategy has it’s drawbacks. Depending on how you use it, margin can be an asset or liability.
One of the biggest issues most beginner traders have is they often start with less than $25,000. To be clear, you don’t need that much to become a profitable trader. Having less than that does put you under the PDT rule and that means making less trades.
When trying to grow your account, you most likely want to take as many trades as you can. Knowing you can only make 3 trades every 5 days can take your mental focus away from where it should be. It can also put more pressure on the trades that you do take.
If you know you only have 3 chances this week to make money, you can start to over analyze each setup. You might stop trading your strategy and only look for homerun trades instead. Anything that causes you to stray from your strategy should be avoided.
What if you’re only trading part time? Three trades every 5 trading days may not be that big of an obstacle for you. And not that this is advisable, but you could in theory put all of your money in each of those three trades.
Whether or not you can grow your account faster with margin is debatable. If you don’t have much screen time invested in watching the market, you might be missing insight that can help you in the future. Earning a full time living from day trading isn’t something you can do with part time effort.
Trading on margin, especially after you have a $25,000 account, can be a great tool in reaching your financial goals as fast as possible. Don’t let the pressure of falling bellow that $25K level derail your trades.
As the name implies, cash accounts only allow you to trade the available funds you started the day with. Once you have placed a trade, that money doesn’t become available to use for again until it has settled.
When you start of the trading day, you know exactly how much you can trade. Depending on your account size and how you size your positions, you can only take a limited number of trades. Once your settled cash reaches zero, you are done for the day.
Pros and Cons of Cash Accounts
Some view day trading in a cash account as the simplest way to grow an account. You start each day knowing exactly how much capital you can risk. You can never be subject to a margin call so you can focus on executing quality trades.
In comparison with a margin account, you cannot use unsettled funds to make trades. For options, trades typically settle the next trading day. Put simply, the buy and sell order has to be reconciled before you can use that money again.
If you used more money than normal on your trading today, you might miss an opportunity to take a trade later in the day. Although you can’t take unlimited trades, cash accounts can make you a better trader.
The goal of any good strategy shouldn’t be to make money, it should be to execute your plan flawlessly. Making money will be the result of following your rules. Although some see using a cash account as a slower means to an end, more reps just makes you better.
Comparison of Margin and Cash Accounts
For day trading which is better to use, a cash or margin account? The answer comes down to your near and far term objectives and how much money you’re willing to invest.
Cash accounts can help you to be structured as your work on your strategy and grow your account. Day trading options with margin can help you quickly scale up your account and strategy if you’ve already got that dialed in.
To help you determine what’s best for you, ask yourself, do I know what my edge in trading is? Am I comfortable trading in different market conditions? Are trades being placed because I’m trying to make $5,000 a day or are they just quality setups?
As you continue your trading journey you may feel the need to step down your size and maybe not even trade on margin for awhile. Some traders go through market trends and drawdowns that shake their confidence. There’s no shame in calling up your broker to remove margin so you don’t make irrational trades.
Knowing yourself is one of the most underrated skills of trading. Master this and consistent profits are so much easier to attain.
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