Q&A
Since You Asked
Confused about some aspect of trading? Professionaltrader Don Bright of Bright Trading (www.stocktrading.com), an equity tradingcorporation, answers a few of your questions.
SWEEPS ON THE NYSE HYBRIDI was wondering if you could elaborate on this statement you made:"You need a nimble program that looks for five-cent moves in a stock andthen hits it on a sweep, or have trigger points already entered to takeadvantage of a sweep." You also mentioned you were working on a programcalled TapeReaderPro. Are you finished?
I don't know about you guys, but my scalper friends and I are strugglinganyway. Thanks for being a leader in our business. --Steelhead
First off, thanks for the kind words. I have made comments about thestate of the scalper these days on several occasions. Scalping alone isfinally becoming a thing of the past. We will always do it, but not asthe primary focus. Market efficiencies have increased, but other doorshave opened for the daytrader -- we all need to adapt.
Some of our guys have triggers that are set off when the REDI quoteline changes color, indicating a sweep or some other significant actionis taking place. Some look for print prices away from NBBO quote and trigger.And to be honest, some more programs are being designed, and after I testthem, we may make them available to our traders.
TapeReaderPro is still being tested, so we'll be making some changesto it for 2007 before any big release.
We have advanced classes coming for our traders just to be sure thatall the profitable methods are available and understood by everyone. Sooften, traders are reluctant to admit they're struggling with something,and it's easier just to show them how they might consider modifying theirstrategies.
Personally, I'm making more money since the hybrid, even though I don'thave the privilege of trading all day (pairs with triggers, mostly).
STOCK OPTIONS AND SPLITSI have read a lot of your answers, and I'm curious. How would youplay the options on a stock split when they arise? --jllm03
I really wouldn't bother since all the floor traders have the stocksplit already accounted for on the theoretical models. Option strike priceswill be modified (or number of convertible shares altered) anyway. In thegood old days, we would simply assume the stock would rise slightly afterthe stock split and play the options accordingly. Our reasoning was thatif a $100 stock became a $30 stock, then more people would be able to buyshares. Worked back then, not so much these days.
FAIR VALUE FOR TRADINGCould you provide me with detailed information on hedging by sellingfutures contracts at a premium to fair value, and buying the underlyingsecurities? I am new to futures and have beginner to intermediate knowledgeof equity trading. --Scott Rohner
Welcome to the world of futures, fair value, and index arbitrage. Thereare things you need to be aware of when using premium/discount to fairvalue for trading. For calculation specifics, you can check Hank Camp'ssite (www.programtrading.com); he has the equation outlined well. Now,let's start with the concept of premium/discount.
You could buy all 500 stocks of the Standard & Poor's 500, or derivethe same risk/reward by buying the futures contracts on the Chicago MercantileExchange. You don't receive dividends on the futures, so that number isdeducted from the fair value calculation. You do, however, have a muchlower cost of carry with the futures since you aren't "spending" all thatmoney to buy the underlying stocks. These concepts are the foundation forfair value and premium/discount to fair value.
If, based on current interest rates, dividends, and time to expiration,the futures are trading at a higher price than calculated, then the traderstend to sell futures. If they cannot buy the futures back with a profit(quickly), then they hedge by buying an index or a basket of underlyingstocks. Some have programs to buy all 500 stocks. This, in effect, is likebuying at the exact parity price (price of all the stocks), and sellingshort at a higher price with the futures. They then wait for a turnaroundin the market (seconds to minutes at times), and reverse the transactionby buying the futures at a discount to fair value and selling back allthe stocks. They account for the costs involved, of course. Thisis the simplest form of futures arbitrage.
We watch the premium/discount all day to determine immediate marketdirection. Basically, we assume that if there is a big premium to fairvalue that the arb traders are selling futures and will be buying stock,so this counts as one of immediate execution indicators (just one of many,of course). For example, we would not buy if we see a big discount to fairvalue since we assume the arb traders will be selling at that particularmoment. All the above is used by momentum traders and scalpers primarily,and is just one of many indicators for all traders.
There are many strategies, many automated, to take advantage of theseminor market disparities. We spend quite a bit of time with these conceptsin all of our training programs (www. stocktrading.com/training.html).This should help get you started. Good luck with your trading.
E-mail your questions for Bright to Editor@Traders.com,
with the subject line direct to "Don Bright Question."Originally published in the March 2007 issue of Technical Analysisof STOCKS & COMMODITIES magazine. All rights reserved. © Copyright2007, Technical Analysis, Inc.
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