Brokerage Firms Offer Accounts According to Creditworthiness
Most brokerage firms offer investors several different types of accounts, each serving a different purpose. The three most common are cash accounts, margin accounts, and option accounts.
The basic difference among accounts boils down to how particular brokers view your “creditworthiness” when it comes to buying and selling securities. If your credit isn’t great, your only choice is a cash account. If your credit is good, you can open either a cash account or a margin account.
A cash account (also referred to as a Type 1 account) is just what you think it is: You deposit a sum of money with the new account application to begin trading. The amount of your initial deposit varies from broker to broker. Some brokers have a minimum of $10,000, while others let you open an account for as little as $500.
With a cash account, your money has to be deposited in the account before the closing (or settlement) date for any trade you make. The closing occurs three business days after the date you make the trade (the date of execution).
A margin account (also called a Type 2 account) gives you the ability to borrow money against the securities in the account to buy more stock. After you’re approved, your brokerage firm gives you credit. A margin account has all the benefits of a cash account plus this ability of buying on margin. A margin account is also necessary if you plan on doing short-selling.
The interest rate that you pay varies depending on the broker, but most brokers generally charge a rate that is several points higher than their own borrowing rate.
An option account (also referred to as a Type 3 account) gives you all the capabilities of a margin account (which in turn also gives you the capabilities of a cash account) plus the ability to trade stock and index options. To open an options account, the broker usually asks you to sign a statement that you are knowledgeable about options and are familiar with the risks associated with them.