Short selling and Rule 2050-what is it?

J

jperl

Here is a question that appeared in "Active Trader" Magazine(Aug. 2001, p56) to which an SEC rule 2050 applies:

I paraphrase the question as follows:

"I recently sold some stock which I had for more than a year and then bought it again and sold it again on the same day. Three weeks later I had a margin call from my broker. How could I have a margin call when I was flat the stock"

Rogan Labier gives a cryptic answer to this question which I won't repeat here, but apparently it has something to due with an elusive SEC rule 2050.

My question is, do any of you know what rule 2050 is, and if so can you give some examples as to how it is applied?:confused:
 
Originally posted by jperl
Here is a question that appeared in "Active Trader" Magazine(Aug. 2001, p56) to which an SEC rule 2050 applies:

I paraphrase the question as follows:

"I recently sold some stock which I had for more than a year and then bought it again and sold it again on the same day. Three weeks later I had a margin call from my broker. How could I have a margin call when I was flat the stock"

Rogan Labier gives a cryptic answer to this question which I won't repeat here, but apparently it has something to due with an elusive SEC rule 2050.

My question is, do any of you know what rule 2050 is, and if so can you give some examples as to how it is applied?:confused:
More...


This is because of a special daytrading margin rule. Whenever you have an overnight position(as this person did), and you exit that position and then reenter it on the same day, it is treated as two transactions. Let me explain:

Suppose you are short 100 shares of CSCO overnight, then you cover it, and then reenter the short position. The covering of your short is treated as a NEW transaction(long CSCO) and your subsequent shorting of CSCO again is treated as closing your long CSCO. This only occurs if you enter the same position after you have exited it.

This way, you can actually exceed your margin because you are not credited with the extra margin you should have gained when you covered your original overnight position.

As for this person you mentioned, I don't know why he got a margin call three weeks later, which is a really long time. furthermore, only certain daytrading brokerages enforce this rule. I believe retail online firms like etrade don't bother with this.
 
Htrader-
Your example seems to be a variant of the one described in my question- Your answer is interesting but I don't think I understand it. Perhaps you could give us a more detailed picture by putting some dollars and cents into the picture to see what the money flow looks like for some imaginary account. I think we would all appreciate it. Also-is there a reference to this weird regulation( I couldn't find anything at the SEC site).
 
Originally posted by jperl
Htrader-
Your example seems to be a variant of the one described in my question- Your answer is interesting but I don't think I understand it. Perhaps you could give us a more detailed picture by putting some dollars and cents into the picture to see what the money flow looks like for some imaginary account. I think we would all appreciate it. Also-is there a reference to this weird regulation( I couldn't find anything at the SEC site).
More...

Let me try again. Assume you have a stock XYZ that is at $20, constant. You are LONG 100 shares overnight at $20, with nothing else in your margin-enable account, no cash. To make things simply, also assume 50% margin maintenance requirement at all times. You are fully maxed on your margin, thus your account is only worth $1000.

There are now two scenarios. In scenario 1, you sell your 100 share position, nothing else happens. In scenario 2, you sell your 100 share position, and then buy it back the same day.

---
Scenario 1: You enter the day with a $2000 position. Assuming a margin requirement of 50% for overnight holds, your buying power is $0.

You now sell that 100 share position at $20, resulting in $2000 in proceeds. You now have an account equity of $1000, with a buying power of $2000
----

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Scenario 2: You enter the day with a $2000 position. Assuming a margin requirement of 50% for overnight holds, your buying power is $0. (same as scenario 1)

You now sell that 100 share position at $20. Then you buy that 100 share position AGAIN. Certain brokers are required to match trades on an intraday basis. This means that when you reenter your long position, your first trade to sell is now considered a short. Why? Because you now have two intraday trades. The first was selling of a stock, the second was buying of a stock. These two trades match each other. Thus this is considered a complete round trip, even though you ended up with stock in your account.

The implication of this is that when you first sold that 100 share position at $20, instead of closing your overnight long, the broker thinks you initiated a NEW short position. Thus requiring $2000 of NEW margin, which of couse you don't have, causing you to have a margin call.
-----

Check out this link by cybertrader if you are still confused.

http://www.cybertrader.com/faq/margin.asp#1

Lastly, I don't know the SEC rule number for this, but I have heard it referred to as a "daytrading call."

Htrader
 
Thanks for the input-I think I understand what you are saying in Scenario #2. While you were preparing this-I received the following from the SEC on rule changes for pattern day trading
It can be found at
http://www.nasdr.com/pdf-text/0126ntm.txt

In the body of this text there is an interesting paragraph which I quote here:

"In addition, the amendments revise the current interpretation that requires the sale and repurchase on the same day of a position held from the previous day to be treated as a
day trade. The amendments treat the sale of an existing position as a liquidation and the subsequent repurchase as the establishment of a new position not subject to the rules
affecting day trades. Similarly, if a short position is carried overnight, the purchase to close the short position and subsequent new sale would not be considered a day trade."

If I interpret this correctly, your scenario #2 would not be considered a day trade.
Is this correct?
 
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