SEC PDT Rules Hurt Small Options Traders

Nov. 30, 2012 10:15 PM ET
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Contributor Since 2012

I am a part time market speculator.

The SEC in 2001 in the aftermath of the dot com crash in the tech sector promulgated some rules on day trading stocks and stock options. As many well know stocks and stock options are two different animals. But in the wake of hysteria involving a daytrader in the Buckhead section of Atlanta, Georgia this concept was ignored. A daytrader in stocks blew up his account and went on an armed killing spree to avenge his loss. The man started with an account worth much more than $25,000, and then proceeded to merrily trade himself down to zero. As often happens with lone nutter gunmen, laws and regulations get put into action that bear little relation to reality.

First, I should explain what the Pattern Day Trading Rule (PDT) is, and how it applies to the thinly capitalized options trader. In accounts with less than $25,000.00, an account holder is only allowed 3 day trades in a rolling 5 day period on stocks and stock options. I can understand not wanting novices to play around with stock prices with their margin accounts, but I do not see that the same process should be applied to stock options, where the novice options trader needs as much flexibility as possible. The PDT rule turns novice options traders into instant shark bait, because they are only allowed 3 bites at the apple. This unfortunate rule does not protect the low net worth options trader as it gives the perverse incentive to such a trader to hold onto losing trades for far too long in order to avoid the PDT rule. This gives better capitalized traders the unfair advantage of triggering the stop losses of PDT restricted option traders, and thus accruing the gains of small traders in a less than fair game. At least if the small trader without PDT, who had a good intuition as to the direction of the market, could later reenter the trade at a better price later in the trading day, if his stop loss was triggered earlier in the day.

Secondly, I would like to explain how stock options are not the same as ordinary shares or stocks. Stock options are derivative contracts that rely on the movements of an underlying asset. With all such contracts it is good to have a tight stop in order to avoid terrible losses as no one is omniscient. Futures traders and FOREX traders rely on tight stops in order to limit losses. As you know futures contracts are contracts based on a good faith deposit on the notional leveraged value of the contract. There are no PDT rules to skew sane risk management. A small futures trader doesn't put in loose stop losses because he does not live under PDT rule. Imagine a futures market with small fishes getting their faces ripped off over some insane pattern trading rule. The sharks would have a holiday. That is what is happening in the stock options market: the waters are bloodied with the chum of small trader chumps.

Thirdly, if up and coming stock options trading houses want more client accounts it should be in their interests to ask for a fair game in these markets. I ask that all concerned sign the No PDT Rule petition that is posted at the Whitehouse website.

Finally, the PDT rule on options trades puts the small trader in the same category as the mark at the carnival midway, who is shooting a BB pellet at a heavy teddy bear. Coincidentally the carnie chump gets the same three chances as the thinly capitalized option trader to hit his target.

I know that there are some who will object to allowing small traders into the options markets as encouraging unwise speculation on the part of those who cannot afford such risks, but I would ask why is not the same consideration given to those who buy more than a $100.00 worth of Powerball lottery tickets or those improvidents who bet the rent money at the race tracks? These games of chance offer far less than fair game odds of winning. At least if I put in a stop loss that amounts to a $1 loss on my $18 AAPL stock option that I often stand to gain 7 dollars for that one dollar at risk. Those are the odds of a coin toss. That same dollar in a state lottery faces a hypergeometric risk distribution at less than fair pay outs for a winning ticket.

Please sign the petition if you favor a stock options market at least as fair as the futures markets.

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