A complete guide to cash accounts
I recently opened a new brokerage account and I faced day trading restrictions. I found out I can bypass these day trading restrictions by opening up a cash only account in Webull. But I wasn’t sure what is a cash only account? Did they have specific rules and restrictions? And how would using a cash account impact my day to day trading? Lets start with the basics
Here’s will cover in this article:
- What is settled cash
- What is t+2 securities vs t+1
- Cash account restrictions
- The pros of cash only accounts
- The cons of cash only accounts
Let’s get started!
What is a Cash Only Account
A Cash only account requires that any securities transactions be payable in full from the funds in your brokerage account at the time of the settlement.
Easy right? Ok, now let’s break down all that finance jargon to actual english.
What is a security transaction?
A securities transaction is a buying or selling a stock.
Do stocks sell instantly?
Stock transactions don’t settle instantly, they settle in about 3 days from the date of purchase or sell. This is commonly listed or referred to as T+2.
“T” being the date of the transaction (buy or sell) and the “2” being the two following business days. For example if you buy a stock on Wednesday(T) your settlement date be Friday (Thursday and Friday being the +2.)
Option contracts are a bit different, so they settle at T+1. At the date of the settlement you must have enough “settled cash” (I will go over what this means in a bit) to cover the entire cost of your transaction. So if you buy an options contract on a Monday(T) your settlement date is Tuesday(+1.)
So lets put it all together.
A cash account is a type of brokerage account where you the investor, must have the full amount of cash needed to pay for a stock or options transaction at the time each transaction you make is to be settled.
So for example, let say on Monday morning at market open time you decide to buy some shares of $UPWK (Upwork) stock totaling $2,000.
So on Wednesday you need to have $2,000 of “settled cash” in your account to pay for your purchase.
Let’s go further in depth on what that means.
There are two types of funds available to you when you trade form a cash account:
- Settled cash
- Available cash
Let’s go over the differences with some examples.
What is Settled Cash in a brokerage account?
Settled cash are the available funds that have been fully credited to your account after a sale of a stock/ options contract or from a bank deposit into your brokerage account (usually referred to as an EFT).
So if you were to sell shares of $FUBO (FuboTV) on Monday for a total of $10,000 those funds would become settled funds on Wednesday.
What is Available Cash in a brokerage account?
As the name implies, available cash are funds that are available to you in your brokerage account but have not been fully settled yet.
Piggybacking off the example above; conducting the same transaction would lead to your account being credited with $10,000 in available cash that can be used to buy stocks or options contracts with some restrictions.
I’ll go over these restrictions below.
Cash account restrictions
Due to the time frame of settlements, cash accounts have several restrictions that you must be aware of:
- Good faith violation
- freeriding violation
- cash liquidation violation
Let’s go over each violation.
Violation #1 – Good Faith Violation
A Good Faith Violation is when a trader buys and then sells a security before it’s paid for with settled funds.
For example, let’s say you that you own $SHOP shares and you’re trying to buy $TSLA shares on Tuesday. But you have $0 in available funds.
You sell some $SHOP shares to cover the purchase of $TSLA shares. Now the $TSLA shares you bought jump 20% in profit that same day and you decide to lock in your profits and sell.
This would incur a good faith violation because the settlement time for securities is T+2. Because you sold stock $SHOP on Tuesday the settlement date would be Thursday. And by selling stock $TSLA before Thursday (the settlement date of selling stock $SHOP) you have technically sold a stock that you did not have enough settled funds to pay for on the settlement date.
What are the consequences of doing this?
Incurring 3 good faith violations in a 12 month period will most likely lead to your brokerage firm placing restrictions on your account that will only allow you to buy securities or options contracts with settled funds vs settled or available. These restrictions usually last 90 days.
Most brokerages will then take further steps outlined in their TOS (terms of service) if these violations become habitual.
Violation #2 – Freeriding Violation
A Freeriding Violation when you sell a security with insufficient funds and sell the same security or options contract to cover the cost of the purchase.
For example, let’s you have $0 available cash to trade on Monday morning and proceed to buy $5,000 of stock “X.”
On Thursday you sell stock “X” for a $6,000 and netting a $1,000 profit to cover the cost of the purchase you made.
The settlement date (the date you needed to have the available funds to pay for Monday’s purchase) was Wednesday.
You again sold a security that you had not paid for in full before selling it.
What are the consequences of doing this?
Brokerages are way more strict with Freeriding Violations as they are violation of Regulation T of the Federal Reserve Board regarding broker-dealer credit to customers.
A single Freeriding Violation in a 12 month period will lead to your brokerage firm placing restrictions on your account that will only allow you to buy securities or options contracts with settled funds vs settled or available. These restrictions last 90 days; Brokerages will then take further steps outlined in their TOS (terms of service) if these violations become habitual.
Violation #3 – Cash Liquidation Violation
A Cash Liquidation Violation takes place when you buy securities (stocks), and then sell other stocks you own for securities after the purchase date to cover the cost.
For example, without any available cash you purchase $5,000 of stock “X” on Monday. On Tuesday you sell $5,000 worth of stock “F” to cover your purchase.
The violation occurs because the settlement date for the purchase of stock “X” will be Wednesday but the funds for the sale of stock “F” wont be available until Thursday, hence you wont have enough settled funds to meet your settlement obligation on Wednesday.
What are the consequences of doing this?
The consequences of doing this are the same as the good faith violation.
If you’re met with 3 cash liquidation violations in a 12 month period will lead to your brokerage firm placing restrictions on your account that will only allow you to buy securities or options contracts with settled funds vs settled or available.These restrictions usually last 90 days.
Most brokerages will then take further steps outlined in their TOS (terms of service) if these violations become habitual.
The pros of cash only accounts
Now with all the information we have gone over we can spot some of the pros of cash only accounts
- No dealing with PDT (pattern day trading restriction)
- You can only use and spend money you have invested
- Having to track your settlement dates makes you think and be more strategic about your trades
The cons of cash only accounts
With the good there is also the bad:
- You are limited by your invested funds
- Tracking settlement dates can become obnoxious
- Staying in compliance of cash account rules and restrictions can be more time consuming (but potentially less costly) than PDT
In summary, cash accounts have their own separate drawbacks and benefits. As someone who will be primarily be using their cash account exclusively for options trading I’m willing to deal with the additional restrictions to be able to exit unprofitable trades much quicker.
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