I recently had beers with a friend who is day trading options (tough gig). He is a relatively new trader who wisely started out with a small amount of capital and hasn’t yet amassed a large trading account. His account currently has less than $25,000 in it which thus restricts his ability to day trade. According to the Pattern Day Trader Rule (PDT), traders with under $25,000 equity in their accounts may not execute more than 4 intraday roundtrip trades in any five consecutive trading days.

He was lamenting the fact that this restriction hampers his trading ability and forces him to skip trades that he’d normally make — and recently he missed out on some very profitable trades.

We discussed some ideas to help him “get around” the PDT, and since then I’ve thought of a couple more ways which I thought I’d share here as I’m sure there are many more of you out there hampered by this mostly idiotic rule instituted by “Big Brother” to protect the little guy — which really does no such thing. (This rule was instituted in the aftermath of the ‘dot com’ bubble — in which our overreaching government wanted to lay the blame of the bubble at the feet of retail day traders, and held a pity party for their losses allowing retail day traders to blame everyone else but themselves. Stupid.)

But I digress…

First off, know that none of these ideas are “perfect” and involve tradeoffs. Nothing can substitute for the ability to simply close out a trade at a profit or loss and be done with it. But the beauty of options is that they give us options (see what I did there?) to work our trades.

Vertical spreading.

Let’s say you’re bullish on $SPY and it’s currently trading at $210. You go ahead and buy one at-the-money (ATM) call option — the July $210 call, for $3.00. (For the purpose of this example, it doesn’t matter what expiration series we’re using, we’ll be trading all options in this same series).

Fast forward to the end of the day, $SPY has rallied to $211 just as you’d hoped. But you don’t want to (can’t) close the trade due to PDT.

Here’s what you can do: Instead of selling your open 210 call, you sell the now at-the-money $211 call against your open option position. You’ll probably get a similar price as you got for your purchase of the 210 call when it was ATM, and thus you’ve eliminated nearly all monetary risk from the position. You’re now holding a 210/211 call vertical spread for a net cost of nearly zero.

Going forward, here are your two most basic and simplest options with this open position:

You can close the entire vertical spread any time after the open of trading the next day, collecting your credit and therefore your profit. (Your amount of profit will be affected by any movement in the position since you initiated the spread as well as any theta decay working in your favor. Could be more, could be less). You can do nothing. Simply hold this spread until expiration where it’ll either be worth a full $100 if SPY closes anywhere above the 211 strike which you’re short, it’ll be worth zero if it closes below 210, or it’ll be worth somewhere between 1–100 dollars if SPY closes in between 210–211.

Ok Sean, this is great when I’m sitting on an intraday profit. But what if I bought the 210 call and then the market sold off $1 and I’m holding a loser?

This is actually an even better situation!

Lets say at the end of the day SPY sold down to 209. You’d love to close your open trade, but here again PDT says you cannot. Well, now in this case you can sell the now at-the-money 209 call against your 210 — again for nearly the same price you bought your 210 call. This will leave you with a short 209/210 credit spread (which will require $100 margin in your account).

Now your cashflow on this trade is near zero (depending again on your executions). And here are your options:

You can close the spread any time after tomorrow’s open. Whatever the debit to close the spread is represents your total loss (will be less than $100). Or, the better option is simply to hold this spread until expiration and hope SPY closes below 209. If it does, the losing trade that you would’ve closed at a loss if you could’ve day traded it now ends up being a near wash. Pretty sweet! Your worst case scenario is SPY actually reverses and heads higher as you had originally hoped. In this case, you’ll take a loss on this short spread (max $100)… but you were expecting to lose anyway! No big deal.

Great Sean. Now I know what to do when holding a winning or losing day trade. But what if SPY just sat in a range all day and did nothing, hugging 210 at the close? What do I do then? I don’t want to hold this risk overnight!

Calendar or Time Spread

In a situation like this, we take advantage of different series.

My friend and I chatted about how it’s not best to open long option positions in the nearest series to expiration. In the case of SPY, there are weekly options with expirations layered out for 6–8 weeks.

So in this example, we’re currently in June and he’s trading the July monthly expirations. He bought the July 210 call and the stock has stayed put all day right where he bought it. Now with the market about to close, he’s uncomfortable holding this risk overnight. If the market has an overnight gap down, he could experience a significant loss.

Since he can’t close this July 210 call due to PDT, his next best option is to sell the same strike in the weekly series one week earlier. He can sell the July8 weekly 210 call for $2.50-ish. This results in a July8/July Calendar spread with a net cost of 50 cents (remember his long July call cost $3.00). Therefore, if SPY were to get crushed at the open tomorrow, his max risk is 50 cents and he can close the trade at any time after the open. However, a new risk now is that if SPY gaps UP significantly tomorrow, he won’t participate on the upside, and may actually incur a loss. Ideally, the market continues to stay put and the next day, the short weekly call can be covered for close to the same price he bought it at, and now he’s back in a long 210 July call, free-and-clear to sell at any time.

This calendar spread trade really should only be put on if you think the market is likely to stay put, but you want to protect against the downside just in case.

So there you have it. A couple spreading options to help you get around Pattern Day Trading Rules. As I mentioned, none of these are perfect solutions as there is additional commission costs, slippage costs, as well as imperfect hedging costs. But it’s the next best thing to having to beg your friends and family for a few thousand dollars to get your account up above PDT thresholds.

Happy trading.