Q&A
Since You Asked
| Confused about some aspect of
trading? Professional trader Don Bright of Bright Trading
(www.stocktrading.com), an equity trading corporation, answers a
few of your questions. |
Don Bright of Bright Trading |
TIME & SALES SHEETS
A friend referred me to you; he says you know everything there is to
know about the stock market. At the end of the day, is there a universal
time and sales sheet, or does every brokerage house have its own? May I
trouble you for the time and sales sheet for AA for Wednesday, July 14,
2004 (by email or a copy)? Or could you give me a site where I can get
it?
Is it true that a market order to cover a short position guarantees
you execution but may take several minutes to fill (and therefore, the
price may be much higher than the price at the time of the order, if
3,000 shares of AA are involved)? -- George
Well, I certainly don't know everything, but thank you anyway. The
time and sales on my datafeed only goes back one day, and AA would have
thousands of line items on any given day. However, you can try going to
http://hunter.tradeoes.com/ to enter the data about your trade.
Regarding limit versus market orders, it works like this: If there is
a 31.20 bid for a stock, and you send a sell order at 31.10 or so, the
assistant to the specialist can simply click and fill the order at the
higher (or best) price available (above the 31.10). Market orders are
usually "matched and batched" by the specialist himself, and this may
cause a bit of a time lag in getting the order completed.
FROZEN BOOK
When the specialist freezes the book (makes the bid/ask 1X1), do
options on that stock continue to trade? Thank you -- putladder
Yes, the options trade on a different exchange, and don't stop
trading unless they "ST" the stock midday (ST = stop trading). The
temporary freezing of the book does not affect options on the underlying
security.
VALUATION OF PUTS VS. CALLS
In an interview with Jeff Yass, Jack Schwager asked him whether there
is a logical reason why out-of-the-money? puts are always priced higher
than the out-of-the-money calls. Yass replied: "There are actually two
logical reasons. One I can tell you, the other I can't." He proceeds to
explain that one reason is that financial panic to the downside is
always a greater possibility than a panic run to the upside. But what is
the second reason, the one he can't say? Always been curious -- illiquid
Okay, let's try to get back to basics. Many institutions have large
portfolios of long stock. They often try to increase their overall
yields by selling call options on the underlying securities. This is not
to say that doing a covered write from scratch makes much sense (you're
better off selling a naked put, which has virtually the same risk-reward
ratio), but if you already own the stock, then bringing in some money
via time decay can certainly help the overall return on the investment.
This, in itself, causes a selling pressure on the calls, which may
result in lower valuations.
Now to the crux: Price out a conversion at any particular strike
price. A conversion, for those who don't know, is a three-way trade: buy
stock, sell call, buy put. This results in a nearly risk-free position
for the holder, but does not allow for much in the way of profits,
either. The stock itself is the long position, and the options reflect a
"synthetic" short position, thus making the overall position
delta-neutral. Delta-neutral simply means that even if the stock were to
rise or drop significantly, there would be no profit or loss. The only
potential for loss, and the reason this position is not completely
risk-free, is when the stock has a closing price, on expiration day,
that is nearly the same as the strike price of the options. Since you
shorted the calls, you don't know for sure whether the holders of these
calls will exercise them. This leaves you vulnerable to having your
stock called away from you.
Conversions and the other side of the trade, called reversals or
reverse conversions, are used for a variety of reasons by many players
in our game of trading. These conversions are usually priced within a
couple of pennies of fair value, which is based on interest rates and
time until expiration. These calculations outweigh the valuations
(Black-Scholes? or otherwise) when determining the pricing of options,
and in determining if they are overvalued or undervalued. If the calls
are overvalued based on historical volatility, you'll find that the puts
are also overvalued. Always calculate the conversion before deciding to
get involved in any options play.
HEDGING US DOLLAR
I trade in US dollars but count my assets in Canadian dollars. If I
have US$100,000 invested, is there a simple, inexpensive method for
hedging against a weakening US dollar? -- Kurb
You can hedge your position with Canadian dollar futures or options
that trade on the Chicago Mercantile Exchange. I suggest that you go
through the online training offered at the Cme -- check www.cme.com for
more information. Good luck!
E-mail your questions for Bright to Editor@Traders.com, with the
subject line direct to "Don Bright Question."
Originally published in the January 2005 issue of Technical
Analysis of STOCKS & COMMODITIES magazine. All rights reserved. ©
Copyright 2004, Technical Analysis, Inc.
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