Hedging and "day trading" in a small acct

[pintodave 86]

Hi everyone,

 

Just to preface this post - if you've been trading for a while or are very experienced, you might read this and say "Duh!", but I had a small "ah-ha" moment today so I thought I'd share it. In short, this is my epiphany of locking in profits via a debit spread.

 

It's with regards to a situation I ran into to trading a small acct (sub 25k in the US) and dealing with frequent trading. I have a fair knowledge of "the basics" with respect to trading complex strategies, greeks, etc... 99% of the time I do not have "round trips" in one day and to this point, I have been more of a "put a trade on, manage if necessary, take a trade off" sort of trader. Where I am still advancing my knowledge is "whole portfolio management" techniques involving multiple positions, rolling, hedging, etc and some more advanced techniques like the interaction of futures with options pricing (vix), etc.

 

So - in case you haven't noticed the markets have been kind of crazy the past few days 

 

Last Friday, I was a naughty monkey and violated the "day trading rules" pretty blatantly by trading SPY puts, so therefore I cannot have any "round trips" in a day for 90 days. Not too big of a deal, but with this market, it could be a hindrance.

 

Today, around lunch I was not too impressed with what I was seeing in the markets so I decided to buy (1) SEP1 187.5 Put for $2.00.

 

My thoughts were to hold it overnight anyways, but after rolling those VIX calls yeterday for a really nice gain & locking in profit while keeping long calls, I got to thinking - if I really wanted to, what could I do to lock in some profits without violating the "day trade" restriction? Remember, I can't sell the position, I can't roll the position...... But I can sell another option against it! DUH!

 

By 3:30pm, I was really happy I had that put, it had expanded to over $4.50. Normally, I'd just sell it, but I couldn't and my plan was to keep it overnight anyways. I ended up not selling an option against it as it was approaching 4pm and I was at work and I really wanted to make sure I understood the "why" of what I was doing and not haphazardly get the trade placed.

 

So in effect, by selling a further away put and creating a debit spread, it is very similar to locking in profits by doing a roll. The max risk in a debit spread is the amount paid, so by sitting on $2.50 in profits, it comes down to how much of that profit I want to lock in. If I think the market could still go down and want to give myself a little room to still profit, I widen the spread a little, if I want to lock in more profit, I just go one strike away from the option I own.

 

To summarize - If you have "small account syndrome" and can't/don't want to burn up a round trip "day trade" but want to lock in some gains, this might be a good way to have your cake and eat it too.

 

To the more experienced traders that actually read this whole post, please post up anything to add to this topic! Or if there is a "hole" in my theory please correct my thought process!

Edited August 26, 2015 by pintodave

[Edwin 63]

Thanks for the tip.  Are you using stop losses in case the trade went against you and the market were to go up and vol were to decrease in the options?

[kdawg 0]

Btw, if you are using IB you can message them and request them to do a PDT reset.  https://ibkb.interactivebrokers.com/article/193

 

Other brokers probably have something similar.

[pintodave 86]

No, it was strictly a directional hedge, that's why I did only 1 contract (even though I wanted to do a few). If it ripped up in my face, my gains would offset the put loss.

 

I very rarely trade single options. If I do a directional trade it is usually via a debit spread, but I don't really do much of that either, the majority of stuff I do is defined risk income-style trades.

[pintodave 86]

Btw, if you are using IB you can message them and request them to do a PDT reset.  https://ibkb.interactivebrokers.com/article/193

 

Other brokers probably have something similar.

 

Thanks, I called TOS and told them I did not plan on bringing the acct up to 25k and asked if there was anything else I needed to do (other than don't be an idiot and "day trade" )

 

They said I was ok to trade, but if I have any issues going forward I will call back and ask them about the reset. If they give me a hard time then all the more reason to switch to IB

[verbotenstylen 6]

One point is that by selling a lower strike put you are capping your potential gains, both via direction and IV. Closing and buying a lower strike keeps your upside unlimited. I'm not saying one is always better than the other, just that the trade-off is real.

[Kim 7,513]

Another thing to consider is hedging with futures. For example, if you buy a call and it goes up and you don't want to sell it the same day, you can sell the futures against it. Of course you need to calculate the number of contracts carefully.

[pintodave 86]

Just an update, after the open this morning, I did end up selling an option against it rather than close it or roll it down.

 

So, after doing that I have a few observations.

 

Yes, rolling it down would allow you to lock in some profits and keep the profit potential bigger should the market keep moving in your favor, but as the market moved against my position today, the p/l curve for the position was a lot more "gentle" by having it set up as a debit spread. So that is the trade off I guess...

 

I did jump the gun a little too soon this morning, I could have locked in more profit by waiting, but who knows what is going to happen in this crazy market.

 

All in all, it was interesting to weigh the different options and observe it in real time.

 

So, net, the position is now a 2 point wide debit spread, max "loss" is a $35 profit, max gain would be a $235 profit... even after the monster rally, the position is still up $75 total and I figured out that I can avoid the "day trading" rule if I need to....