Contents
- What Is The Pattern Day Trading Rule?
- What Happens If I Violate Pattern Day Trader Rules?
- How Your Open Trades Affect PDT Requirements
- Conclusion
Being able to trade from anywhere in the world and be your own boss is a dream for many people.
Most do the right thing by getting themselves educated on how to trade options correctly and finding themselves a mentor.
Unfortunately many do not do the right thing and they merely jump right into day trading.
Pretty soon they wake up one day with an alert from their broker that says their buying power has been reduced or that their account has been suspended.
Confused, the novice trader sees that they have a positive cash balance and don’t owe the broker anything, so they don’t understand why this has happened.
Unfortunately, they’ve violated trading rules and have just been flagged as a Pattern Day Trader (PDT).
Thankfully, with a bit of up-front education and coaching you can avoid breaking any rules.
Read on to understand what the PDT rules are and how you can best avoid violating them.
What Is The Pattern Day Trading Rule?
The PDT rule states that you are a pattern day trader if you:
- Execute four or more day trades within five rolling business days, and;
- Your margin account value is less than $25,000, and;
- The number of day trades make up more than 6% of your total account trade activity.
You might think that you would never do this, but imagine a period of unusually high market volatility.
You enter a trade and a few hours later the market moves dramatically or a big piece of news comes out, which forces you to change your mind.
As a result you close the position and wait, deciding to execute a trade the following day.
Rinse and repeat a few times and suddenly you’ve accidentally violated the rules and you get flagged as a PDT.
Since there are some strict definitions involved in defining a PDT, we’ll cover those so you can avoid getting caught out. The first is a ‘day trade’ – simply put, this is when you open a position and then close it on the same day, like a 0 DTE SPX Options Trade.
This could be buying and then selling, or if you’re going short, it means selling first and then buying.
The second is a ‘margin account’, which is simply the capital you put into your account to use as collateral for buying or selling options.
A final note on PDT, some traders actually self-identify as day traders and so if that’s the case just advise your broker.
What Happens If I Violate Pattern Day Trader Rules?
Different brokers may have slightly different procedures they follow when PDT rules are violated, so always confirm the process with your broker first.
In general, when you breach the PDT rules for the first time, most brokers are somewhat forgiving.
They’ll start by flagging your account as a PDT and then monitor your trading activities to see if you become a repeat offender.
If you break the rules again (or if they have reason to believe you are a genuine PDT in the first instance) they will enact one or more restrictions on your account.
The first restriction will be the requirement to maintain a minimum equity amount of $25,000, even if you do not intend to be a day trader.
You will need to deposit funds as soon as possible to meet this requirement.
In the meantime, your broker will likely suspend all trading privileges for 90 days until you meet the minimum equity requirements.
The next restriction will be to remove your ability to open new trades and only allow you to close existing, open trades.
The final restriction is to remove your ability to use margin when trading, limiting any transactions to cash transactions only.
The restriction on using margin will not necessarily be lifted as soon as you meet minimum equity requirements as the broker may want to see a pattern of adhering to PDT rules first.
If you do get flagged as a day trader and it was an accident (and you don’t intend to be a day trader going forward), give your broker a call straight away and they may be able to help you avoid trading restrictions.
Otherwise, if you decide to day trade it might be advantageous for you to be flagged as a PDT.
The reason being, is that PDTs often have access to margin accounts with buying power up to four times their actual cash balance.
Provided you keep your minimum account value above $25,000 this might be a desirable option for you.
How Your Open Trades Affect PDT Requirements
The requirement for $25,000 in your account at all times is not as simple as simply depositing $25,000 and then trading whatever you want.
The reason being is that the account balance is affected by any open trades you might have at the time.
For example, if you have any open positions, they will usually contain some portion of unrealized gains or losses.
Your opening equity for the day is determined by what’s called the ‘marked-to-market’ value of your open positions, where ‘marked-to-market’ is simply the value of those positions if you were to immediately sell/buy them at current market prices.
The danger you have then is that if you are holding positions that currently have an unrealized loss, these will reduce your trade equity at the beginning of the day (subject to the marked-to-market value).
The result of this is you may temporarily dip below the $25,000 minimum account equity requirement and trigger a PDT classification.
It gets worse if you’re holding any stocks on margin as they come with a maintenance margin that will also need to be deducted from your account equity position.
So always keep an eye on your maintenance margin, unrealized returns and cash equity to ensure you meet required equity minimums.
Conclusion
A pattern day trader is one who executes four or more day trades within five rolling business days, has a margin value of less than $25,000, and the number of day trades make up more than 6% of their total account trade activity.
If identified as a pattern day trader, brokers will place several restrictions on the account such as requiring additional margin, 90-day trading suspensions, and other measures.
As unrealized gains and losses contribute to the calculation of an account’s equity, it’s important for traders to keep an eye on them to ensure they don’t accidentally breach pattern day trading rules.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
How the PDT rules applies to option trades is not quite clear. What constitutes the same security on an option? Does it apply to all options with the same underlying? Is it all options with the same DTE? Or is every combination of strike price, DTE and put/call each considered a different security? If I rolled a four-sided spread like an iron condor out each week, which involves closing 4 contracts then opening 4 similar contracts to expire the next week, does that constitute 4 day trades, since 4 contracts were bought and 4 contracts were sold all on the same day on the same underlying stock? Is a spread considered 1 trade as a group or 1 trade per leg? And is each leg considered the same security? “Rolling out” would be to a new DTE group, but are those still considered the same security for PDT rules? Or does PDT rule apply only when you buy & sell a very specific option in the same day, for example a 22 Oct call for AAPL with a strike of 155?
Do some brokers allow option trading with a cash account? Because the PDT rule only applies to margin, correct? If you let cash settle first you can trade as much as you want, right?
Cash accounts are not subject to pattern day trading rules but are subject to GFV’s. Pattern day trading (PDT) rules only pertain to margin accounts.
A good faith violation (GFV) occurs when a cash account buys a stock or option with unsettled funds and liquidates the position before the settlement date of the sale that generated the proceeds.