Piling up your cash?
Successful options trading requires a handful of essential skills. Here is a list:
- knowledge of your platform (thinkorswim)
- market conditions
- technical analysis of stock charts
- strategic thinking and action
- risk management
- record keeping and critical review
- cash management
Cash management? By this I mean the use and control of the money in your account. Let's start with the $100,000.
Account Basics
The first thing you should control is the type of account, which should be "margin account". For stock traders, this means that you can borrow from your brokerage company and leverage your account 2:1. As options traders, we don't borrow money, as we are primarily sellers of options, and so our income is received from buyers. Options purchases cannot be leveraged but if you own stock 100% it can be used as security for options trades or as "margin".
Every trade is either a Debit or a Credit to your account. If it involves more than one leg, such as a vertical spread, it will still be Net Credit or Net Debit. A straight purchase of a Put or Call takes money out of the account, and when the option is sold money is put back in. When we place a credit spread, however, the brokerage firm does not take money out of our account, but dedicates a cash amount to cover any potential loss on the trade. Not until the trade is over is any loss taken from the account. Income (such as a credit spread), on the other hand, is credited immediately the trade is opened.
Next account basic is the three types of reports on your account. Net Liq & Day Trades refers to the moment-to-moment value of all assets in the account, including cash and option positions. 
Cash & Sweep Vehicle is usually fixed between trades and only includes your initial deposit plus losses and credits as of this moment. (You will notice that this amount exceeds the net liquidation value. This is not typical, but a feature of our trading system.)
EXAMPLE: In the account shown, the actual amount of cash is $604,486.62 but if all positions were liquidated, the net result would be $548,786.62. Why the difference? Think of a house. You bought it for $100,000 with a 90% mortgage and have paid $5,000 off the mortgage. If the house is till worth $100,000, your net liquidation would now be $15,000.
Option Buying Power refers to how much margin money is left to use in your option trades. If you place a trade requiring $4,500 of margin, then your remaining buying power will reduce by $4,500. If you have almost none left in this category, then you have assigned the total account to trades, and will have to close some in order to free up money for new trades. When a trade is closed, margin money is freed up to be use again for another trade.
Cash Build Up
If you buy options, you lose cash. If you sell options, then cash is put into your account. If you are mostly selling options, I recommend that you build up the cash in your account to 120-130% of the initial deposit and maintain an excess cash amount as long as possible. If you start an account with exactly $100,000 and then sell a credit spread, you will receive cash and the margin amount will be also be deducted from your "available" buying power. If the amount of cash rises to perhaps $120,00 you can place 20% more trades, so take advantage of this fact.
EXAMPLE: Kane initiates his first trade: SELL 10 Apr 180/175 Put spread for $1.40 credit. This trade will take $3,600 margin money (Margin is difference between strikes minus any credit.) As a result, he takes in $1,400 cash, and his buying power is reduced by $3,600. Under "Account Info" he will now see
- Option Buying Power $96,400
- Net Liq & Day Trades $100,000
- Cash & Sweep Vehicle $101,400
Kane immediately adds another call spread: SELL 5 July 450/460 BLK Call spread for $2.30. His "Account Info" will now read (assuming no change in value of the options)
- Option Buying Power $92,550
- Net Liq & Day Trades $100,000
- Cash & Sweep Vehicle $102,550
Kane is building his cash up! In the HOT Trading System, we would recommend that Kane keep adding another 15-20 trades and build up the Cash amount to perhaps $125,000. What is that extra cash? Its his future profits, if he manages the trades well. It also gives him a resource to pay if he loses money on a trade.
Paying for Losses
For this reason, traders must keep in mind that if they close a trade at a loss, the money is forever gone. So be slow to close your losses and quick to bring in credits! Remember that money you give up is gone forever! This just as true for "rolling trades". If you encounter a loss on a trade, then before you close the trade, go and find money to pay. Don't take it out of your own money unless it is absolutely necessary to do so. It will still hurt a little to make the payment, but at least it was from "future profits".
Managing Stock Assignments
You can be put stock anytime, but mostly it happens close to expiration or when the price sits between your sold strike and your insurance. In this space, you are technically in no-man's-land, and can be targeted by the computers. Next thing you know, you have been assigned or shorted stock. Why to do?
Firstly, don't panic. Do NOT immediately close the trade for a loss! Nothing bad has happened, and you can keep all the money you collected on the trade. There's no need to pay back any credit you received. That should be good news. Next, you still have the insurance you bought so you are protected in case the price moves against your new stock position. (For handing stock assignments after expiration of the options, see the chapter on Expiration.)
Put the stock? When you are "Put" stock, you will see a +100 (or +500 or perhaps +1,000) shares in your Trade/Activity & Positions tab. You are given four trading days to either buy the stock by adding cash to account, or simply selling it. In the meanwhile, you will find a big negative number in your account ("the bill") and may not be able to trade anything else until you have cleared the stock assignment.
Place an order to sell the total position when you are profitable. Sometimes this can be done by selling a Call above the current price, or simply placing an order to sell above the assignment price.
Short the stock? If you a shorted the stock, you will find a -100 (or -500, 05 -1,000) shares of stock in your account, and a large credit of many thousands of dollars. If the stock goes down from that point, simply buy back the short position for a profit. If it goes up, you should have protection in place (another Call option), so don't panic. Sell a Put to collect some money and try to close the trade whenever the whole arrangement is profitable. You will be able to get out with zero loss if you are patient and smart about collecting a little more money.
There is one bug. If you are assigned or shorted stock, it is likely your account will be effectively "frozen" until you settle. That means you will not be able to enter new trades, or even add closing trades. But there is a work around you can have in place: make sure that you place a closing order on every trade you open from the day that it is opened. That way, you will always be able to close your trades even if the account is suspended by the assignment.
Taxation
There will be a whole seminar on taxation in the near future, but here are some useful resources:
Forbes Magazine on Tax Treatment of Options
Options Clearing House PDF on Taxes and Investing
Tasty Trade offers answers on Tax Laws
Raymond James on Options, Puts, and Calls: Tax Planning
NASDAQ on How to Hire A Tax Professional
HOMEWORK
1. Review the positions in your PaperMoney and other accounts and make sure you understand the margin on each position. What is the available margin? Are you over-invested in some positions? Do you need to make changes?
2. What is the Cash in each of your accounts as a percentage of the Net Liq ? Is it over or under 100%? Do you need to take any action?
3. Do you have stock positions or assignments in your account, e,g, -500 NFLX. Manage these through to profitability.
4. If you get assignments during this trading week, then create a plan for each position to keep your account in good shape and maybe make some profit.
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