Wash Trade Question

kevinkdog · April 30th, 2022, 08:07 AM

elitecamper

If you hedge NQ with MNQ you can do it in the same account. You won't need two separate accounts for that.

Agreed, and if you have it setup correctly, you should be able to trade 2 NQ strategies in the same account also. You just trade the net position. That is definitely the cheapest solution. Being long and short is equivalent to being flat.

The problem is not every trading platform works well with this. Tradestation 9.5 had a lot of issues with this, but version 10.0 seems to handle this a ton better.

April 30th, 2022, 08:43 AM

bobwest

It's not a hedging rule, it's Rule 534:

Rule 534 (�Wash Trades Prohibited�)
No person shall place or accept buy and sell orders in the same product and expiration
month, and, for a put or call option, the same strike price, where the person knows or
reasonably should know that the purpose of the orders is to avoid taking a bona fide market
position exposed to market risk (transactions commonly known or referred to as wash
trades or wash sales). Buy and sell orders for different accounts with common beneficial
ownership that are entered with the intent to negate market risk or price competition shall
also be deemed to violate the prohibition on wash trades. Additionally, no person shall
knowingly execute or accommodate the execution of such orders by direct or indirect
means.

Link: https://www.cmegroup.com/rulebook/files/cme-group-Rule-534.pdf

So, this says you can't. However....

I just read @kevinkdog's post, and what he is doing makes sense to me (and is not "hedging"). As I understood him, he had two algos and they were executing independently, and for different reasons. One said to go short, one said to go long. As I understand his point, he is saying that these should not be regarded as related and offsetting transactions, because the reasons they were taken were based on different systems that were independent and that happened to take different positions. I think he explained it well, and it did succeed with his broker. But notice that he had to argue long and hard to get it accepted.

I think a key phrase in the rule I quoted is "with the intent to negate market risk or price competition." Pretty clearly, this was not the point to Kevin.

So, in your case, what is the point? If you are running independent, automated systems that just happen at some times to be on different sides, you could make Kevin's argument.

On the other hand, one of the reasons for the rule, as I understand it, is to prevent people from putting in a lot of fake, no-risk trades that they want to fool the other market participants about, to generate the appearance of activity. This could conceivably be a problem for you, because what you are doing could raise that question. Using different brokers would keep it off the broker's radar (neither would know about the other), but I have no idea if it would attract any other attention.

So at first look, it appears not to be OK, but there is always the possibility that you could win the argument if you could show the trades are legitimate and not intended to be fakes. Which might take some work on your part. As a practical matter, given that you would be using different brokers, it might never come up. But if it did, using different brokers could easily look like an attempt to conceal something.

So what matters is what you are doing, and why. You probably would have to make the case that your trades are legitimate and not intended to create a false appearance of activity by putting in no-risk, mutually cancelling trades. This can be argued, if it's the actual case, but may take some arguing.

I'm no expert, and certainly not a lawyer, but this would be my take on it.

Bob.

Thanks again for your support. I wasn't even aware of Rule 534. I think I had a bad interpretation of the Dodd Frank Act which I perceived to be you can't hold a long and short position simultaneously on the same equity. And the only way around it was to use 2 different brokers.

May 4th, 2022, 06:29 AM

bobwest

Rule 534 (�Wash Trades Prohibited�)
No person shall place or accept buy and sell orders in the same product and expiration
month, and, for a put or call option, the same strike price, where the person knows or
reasonably should know that the purpose of the orders is to avoid taking a bona fide market
position exposed to market risk (transactions commonly known or referred to as wash
trades or wash sales). Buy and sell orders for different accounts with common beneficial
ownership that are entered with the intent to negate market risk or price competition shall
also be deemed to violate the prohibition on wash trades. Additionally, no person shall
knowingly execute or accommodate the execution of such orders by direct or indirect
means.

Link: https://www.cmegroup.com/rulebook/files/cme-group-Rule-534.pdf

I think the perception of wash trading/rule 534 in this thread is wrong.

The wash trading prohibition is intended to stop people washing trades (ie buying and selling at the same time and price) with the intention of giving the appearance of market activity that isn't correct. It is not to stop people hedging or having offsetting positions during the normal course of business. (Although the exchanges don't want you to have offsetting positions because it makes the Open Interest calculations inaccurate.)

In the example given

tradingraven

I'm trading the NQ. I have 2 systems. I use 2 different brokers for each system. My first system I'm long on the NQ. The second system I'm short on the NQ. Does this violate the hedging rule.

Assuming the 2 systems are independent systems, and the intent of each individual system is to make money, then the intent of the two systems when combined is obviously not to "negate market risk or price competition". This is the argument @kevinkdog was making in his Tradestation CFO example.

Regarding offsetting positions, large trading entities have lots of traders, trading in multiple accounts, across multiple brokers. Offsetting positions can and do happen.
Simple example a, small oil trading desk.
Trader A is hedging a refinery position and he has sold the June Gasoline Crack Spread. Specifically he has sold RB_M and bought CL_M.
Trader B is a crude oil trader, thinks the market is a little over supplied and is short WTI time spreads. Specifically he has sold CL_M and bought CL_N.
Trader C is buying a North Sea cargo that he is bringing to the States. To lock in the spread he has bought June Brent and sold July WTI (it takes two weeks to get here). Specifically he has sold CL_N and bought BZ_M
The CL_M and CL_N positions theoretically offset and the companies net position is Short RB_M and Long BZ_M but I can tell you from experience that's not what is in the accounts.
Now imagine the same situation, but on the scale of someone like BP, where they have 100s of traders, spread around the world, trading for different entities, with different economic drivers and different profit centers.

May 4th, 2022, 08:02 AM

SMCJB

I think the perception of wash trading/rule 534 in this thread is wrong.

The wash trading prohibition is intended to stop people washing trades (ie buying and selling at the same time and price) with the intention of giving the appearance of market activity that isn't correct. It is not to stop people hedging or having offsetting positions during the normal course of business.

I think that the original poster, @tradingraven, had a misunderstanding of the rule against wash trades, which is why he originally titled this thread as "Hedging Question." He has clarified that he had a mistaken interpretation of the issue, after the discussion in the thread.

Wash trades are deliberate attempts to draw other traders to a particular instrument by producing fake trading activity, to give the person doing the wash trades someone to unload their position onto.

Wash trades are not a hedge, nor the result of situations such as @SMCJB outlined, where a firm may have many positions, long or short, due to having many traders pursuing different strategies, nor the one detailed by @kevinkdog, where one trader has two automated systems that happen to have offsetting positions because they are running different logic that may dictate different positions at the same time, which seems to be what @tradingraven had in mind in his original post for the thread.

Because of this, I am changing the thread title from "Hedging Question" to "Wash Trade Question," which more accurately reflects the issue, and which would tell other traders in the future what the thread is about. It actually is something that comes up now and then, and traders may want to know what the actual prohibition is, and the reason for it.

Bob.

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Wash Trade Question