Do Day Trading Rules Apply to Options?

Day trading involves buying and selling financial instruments within the same trading day to capitalize on short-term price movements. This rapid approach requires a thorough understanding of the regulatory framework governing these transactions. Ignoring these rules can lead to unexpected account restrictions.

Understanding Pattern Day Trader Rules

The Financial Industry Regulatory Authority (FINRA) established the Pattern Day Trader (PDT) rule under FINRA Rule 4210 to oversee frequent trading. A “day trade” involves the purchase and subsequent sale, or sale and subsequent purchase, of the same security within the same trading day. This rule applies to individuals trading in a margin account, which allows investors to borrow funds from their broker.

An investor is designated as a Pattern Day Trader if they execute four or more day trades within a rolling five-business-day period. This designation also requires that these day trades constitute more than six percent of the total trades made in the margin account during that same five-day timeframe. Once identified as a Pattern Day Trader, an account must maintain a minimum equity balance of $25,000 at all times. This equity can be a combination of cash and eligible securities, and it must be present in the account before any day trading activities commence.

Applying Day Trading Rules to Options

The Pattern Day Trader rules extend directly to options trading, meaning that buying and selling options contracts within the same day counts towards the day trade limit. For instance, if an investor buys a call option in the morning and sells it later that afternoon, this transaction is considered one day trade. Similarly, selling a put option and then buying it back before the market closes also constitutes a day trade.

The $25,000 minimum equity requirement for Pattern Day Traders also applies to options trading conducted in a margin account. Trading options in a cash account, while not subject to the PDT rule, introduces other considerations related to settlement periods. Options contracts settle on a T+1 basis, meaning the transaction completes one business day after the trade date. If funds from an options sale are used to purchase another option or security before the initial sale has settled, it could lead to a “good faith violation.”

Consequences of Rule Violations

Failure to comply with day trading regulations can result in significant account restrictions. If a Pattern Day Trader’s account equity falls below the $25,000 minimum, they may face a prohibition from further day trading until the account is restored to the required level. This restriction can be a 90-day trading suspension, limiting the account to liquidating existing positions but not opening new day trades. Brokers may issue a “day trade call” if a trader exceeds their day trading buying power.

A day trade call is a demand for additional funds to cover the excess trading activity. The trader has up to five business days to deposit the required funds to meet this call. Failure to meet a day trade call can lead to further restrictions, such as the account being limited to trading on a cash-only basis for a period, often 90 days.

In cash accounts, “good faith violations” occur when securities are bought with unsettled funds and then sold before those funds clear. A “free riding” violation happens if securities are bought and then sold without ever paying for the initial purchase. Both good faith and free riding violations can result in a 90-day restriction where the account can only trade with fully settled cash.

Navigating Day Trading Requirements for Options

Options traders can employ several strategies to remain compliant with day trading rules. Maintaining an account balance consistently above the $25,000 threshold in a margin account helps avoid Pattern Day Trader restrictions. For those with less capital, carefully managing the number of day trades to stay within the three-trade limit over a five-business-day period is important.

Trading in a cash account avoids the Pattern Day Trader designation, but requires adherence to settlement rules. Traders must ensure that funds from sales have fully settled before using them for new purchases to prevent good faith or free riding violations. Tracking day trades, either through brokerage statements or personal logs, helps prevent inadvertently crossing the PDT threshold. Planning trades to hold positions overnight can also bypass the day trade count, as only trades opened and closed on the same day are considered day trades. Many brokerage firms offer tools or alerts that can help traders monitor their day trade count and account equity to help navigate these requirements.