Cash account trading and free ride restrictions

A cash account is defined as a brokerage account that does not allow for any extension of credit on securities. This includes retirement accounts and other non-retirement accounts that have not been approved for margin. While customers may purchase and sell securities with a cash account, trades are only accepted on the basis of receiving full payment in cash for purchases and good delivery of securities for sales by the trade settlement date.

If a cash account customer is approved for options trading, the customer may also purchase options, write covered calls, and cash covered puts.

Short selling, uncovered option writing, option spreads, and pattern day-trading strategies all require extension of credit under the terms of a margin account and such transactions are not permitted in a cash account.

Rules for payment of securities transactions executed in accounts are established under Federal Reserve Board Regulation T. Under these guidelines, purchases in cash accounts can be accepted under the following conditions: if there are sufficient funds in the account to fully pay for the purchase  at the time the trade is executed or the customer makes a good faith agreement to promptly make full payment for the purchase on or before the settlement date and before selling the security.

Settlement date  may vary by security type and conditions of the trade but is generally three business days for equities and one business day for options and most mutual funds. Fixed income security settlement will vary based on security type and new issue versus secondary market trading.

It is important to note that the definition of sufficient funds in a cash account does not include cash account proceeds from the sale of a security that has not settled. It also does not include non-core account money market positions.

A good faith violation occurs when a security purchased in a customer’s cash account is sold before being paid for with the settled funds in the account. This is referred to as a good faith violation because while trade activity gives the appearance that sales proceeds will be used to cover purchases (where sufficient settled cash to cover these purchases is not already in the account), the fact is the position has been liquidated before it was ever paid for with settled funds, and a good faith effort to deposit additional cash into the account will not happen.

Good faith violation example 1:

Cash available to trade = $0.00

• On Monday morning, a customer sells XYZ stock netting $10,000 in cash account proceeds.
• On Monday afternoon, the customer buys ABC stock for $10,000.
• If the customer sells ABC stock prior to Thursday (the settlement date of the XYZ sale), the transaction would be deemed to be a good faith violation because ABC stock was sold before the account had sufficient funds to fully pay for the purchase.

Good faith violation example 2:

Cash available to trade = $10,000, all of which is settled

• On Monday morning, the customer purchases $10,000 of XYZ stock.
• On Monday mid-day, the customer sells the XYZ stock for $10,500.
• At this point, no good faith violation has occurred because the customer had sufficient funds (i.e. settled cash) for the purchase of XYZ stock at the time the purchase was made.
• Near market close, the customer purchases $10,500 of ABC stock.
• A good faith violation will occur if the customer sells the ABC stock prior to Thursday when Monday’s sale of XYZ stock settles and the proceeds of that sale are available to fully pay for the purchase of ABC stock.

Good faith violation example 3:

Cash available to trade = $15,000, of which $5,000 is from an unsettled sell order from Friday that is due to settle on Wednesday.

• On Monday morning, the customer purchases $15,000 of ABC stock.
• The purchase is not considered fully paid for because the $5,000 in proceeds from the sale of stock from the previous Friday will not settle until Wednesday.
• A good faith violation will occur if the customer sells the ABC stock prior to Wednesday.

A cash liquidation violation occurs when a customer purchases securities and the cost of those securities is covered after the purchase date by the sale of other fully paid securities in the cash account.

Cash liquidation violation example 1:

Cash available to trade = $0.00

• On Monday, the customer purchases $10,000 of ABC stock.
• On Tuesday, the customer sells XYZ stock, which had been purchased the previous month, for $12,500 in proceeds (due to settle on Friday).
• A cash liquidation violation has occurred because the customer purchased ABC stock by selling other securities after the purchase. When the ABC transaction settles on Thursday, the customer’s cash account will not have the sufficient settled cash to fund the purchase because the sale of the XYZ stock will not settle until Friday.

A free riding violation occurs when a customer purchases securities and then pays for the cost of those securities by selling the very same securities.

Free riding example 1:

Cash available to trade = $0.00

• On Monday morning, the customer places an order to purchase $10,000 of ABC stock through a representative on a good faith agreement of prompt payment by settlement date (Thursday).
• No payment is received by settlement on Thursday.
• On Friday, the customer sells ABC stock for $10,500

A free riding violation has occurred because no payment was received for the purchase.

Free riding example 2:

Cash available to trade = $5,000

• On Monday morning the customer places an order to purchase $10,000 of ABC stock intending to send $5,000 payment later in the week (before Thursday) through an electronic funds transfer.
• On Tuesday, ABC stock rises dramatically in value due to rumors of a takeover.
• On Wednesday morning, the customer sells ABC stock for $15,000 and decides it is no longer necessary to send the $5,000 payment.
• On Thursday, the customer does not complete the electronic funds transfer.
• A free riding violation has occurred because the $10,000 purchase of ABC stock was paid for, in part, with the sale of ABC stock since the customer did not deposit into the account the additional $5,000 to cover the purchase price of ABC stock by settlement date.

A cash account with three good faith violations, three cash liquidation violations or one free riding violation in a 12-month period will be restricted to purchasing securities only when the customer has sufficient settled cash in the cash account at the time of purchase. This restriction is effective for 90 calendar days.

Cash available to trade is defined as the cash dollar amount available for trading in the core account without adding money to the account. This balance includes intraday transaction activity.

For unrestricted cash accounts, all buy trades are debited and all sell trades are credited from the cash available to trade balance as soon as the trade executes, not when the trade settles. For example, if the core is $10,000, a deposit of $10,000 is received today, and the account has a $10,000 credit balance from unsettled activity, the cash available to trade balance would be $30,000.

For cash accounts restricted for free riding or good faith violations, the cash available to trade balance will not include unsettled cash account sale proceeds.

Day trading

Day trading is defined as buying and selling the same security (or executing a short sale and then buying the same security) during the same business day in a margin account. “Pattern day traders,” as defined by FINRA (Financial Industry Regulatory Authority) rules. must adhere to specific guidelines for minimum equity and meeting day trade margin calls.

The term pattern day trader generally means any customer who:

• Executes four or more day trades within a five-business-day period, or
• Incurs two unmet day trade calls within a 90-day period.

A non-pattern day trader account, or an account with only occasional day trading, becomes designated a pattern day trader if it meets either of the above criteria. To remove the pattern day trader status on an account, the account must not have any day trades for 60 consecutive days.

Minimum equity requirements for pattern day traders

Pattern day traders must maintain a minimum equity of $25,000 in their margin account at all times or the account will be issued a day trade minimum equity call. Non-marginable securities such as mutual funds that haven’t been held for 30 days and options are not counted toward margin equity. For day traders not classified as pattern day traders, the requirement is the minimum margin equity of $2,000 required by all Fidelity brokerage accounts. Day trade minimum equity call

A day trade minimum equity call occurs when the margin account equity in a pattern day trader account falls below $25,000. This minimum must be restored within five business days with a deposit of cash or marginable securities. If the day trade minimum equity call is not met, then the account’s day trading buying power will be restricted for 90 days. Note that there is a two-business-day holding period on funds deposited to meet a day trade minimum equity call or a day trade call. Day trade buying power

Day trade buying power is the amount that a customer can day trade without incurring a day trade call.

The rules generally permit a pattern day trader to trade up to four times the minimum margin excess (also referred to as exchange surplus) in the account using time and tick and as of the close of business of the previous day. Time and tick calculates margin using each trade in the sequence that it is executed, using the highest open position during the day. This information is only available to eligible day traders on Fidelity.com or Active Trader Pro ® .

Note: Money market and cash credit balances are not included in the calculation of exchange surplus and, consequently, do not factor into day trade buying power.

Example:

Your account has $20,000 more than the minimum equity requirement for the marginable equities you hold. As a result, your day trade buying power is $80,000 (four times the exchange surplus). If you bought $80,000 of XYZ Corp. at 9:31 a.m. and bought $70,000 of JGG Ind. at 10:00 a.m. then subsequently sold XYZ and JGG, a day trade margin call would be issued the next business day. (One way to avoid the margin call in this example would be to sell XYZ Corp. before purchasing JGG Ind.).

The account’s day trade buying power balance has a different purpose than the account’s buying power value. If you are intending to day trade, then the day’s limits are prescribed in the day trade buying power field. If you do not plan to trade in and out of the same security, in the same day, then use the buying power field to track the relevant value.