Since You Asked
| 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 |
PROGRAM TRADES
I read an online chat that talked about programmed trades occurring on the Nasdaq. I don't trade that market, but found it interesting. It made me wonder, with more than 50% of NYSE volume in programs, whether it is important to investigate that process and learn more about it. Currently, I am knowledgeable with regard to index arbitration (program trades that work the premium), but know little about other types of program trades. To what extent does your training deal with that subject? I am hoping to find a resource for learning more about the subject generally. I appreciate any comment you might have. -- Steve
First, we have to define program trades. There is the legal definition, which has rigid guidelines and is subject to trading curbs and other restrictions. I prefer the broader definition, which includes any type of automated response to the market via programming. This takes on many forms, from simple, if/then-type DDE-link (dynamic data exchange) activated or ActiveX responses, to elaborate massive line item order entries using FIX protocol.
I have mentioned Hank Camp a few times, and you might want to check out his website at: www.programtrading.com (for the more technical applications).
Our group in Canada, PairCo, has several elaborate programs for various types of trading. Pair trading is obviously a big focus for them, but they have quite a few other strategies that they have automated. There are black box-type programs that can simply be left running (not advisable for most people), and hybrid black-box programs that require a lot of monitoring. You can find out more about this at www.pairtrader.com. These experts grace the Bright Trading training grounds at virtually every advanced session.
PLACING OPENING ORDERS
How do you place opening orders for stocks that have a premarket indication? For example, yesterday KSS closed at 48.74. This morning, it was indicated at 49.50 low, 50.00 high. Would you set an envelope around an average of these (49.75)? Thanks. -- James
I would only move the offer up (you never want to buy a stock in the lower end of a much higher gap opening). Leave the bid alone, and place the offer at 49.75 or so (top half or top third of the indicated range).
COMMODITY OPTIONS
I am a novice to commodity options trading. Would you explain a trade using grains as an example, including the potential risk, gain, and cost? -- Louis
For the most part, options are traded pretty much the same way regardless of the underlying security or commodity. Options are valued based on volatility, time until expiration, and interest rates (called cost of carry). There is a fundamental difference between options traders. Some of them are risk-averse, and therefore they want to buy puts or calls. This way, their loss is limited to whatever they paid for the options (this is called the premium). This side generally consists of retail speculators. The other side, which includes most floor traders and other professionals, like to sell this premium to collect time decay. Every day that goes by, the option is worth a bit less. Many options simply expire worthless, so the profit is based on whatever price they sold for. It is more risky to sell options, because the underlying commodity has an infinite possibility of moving up in price. However, if you have a full understanding of the options, futures, and other instruments, then you can hedge your positions in a myriad of ways. As with most things, being able to hedge with cross-market instruments is a big edge.
Rather than take the whole page here, I'm going to give you a site that I happened across on the web: FuturesBasics.com. I don't know these people, but their basic explanation is clear and concise. You can search the site for examples of trading options on corn.
HEDGING SPYs
Suppose I buy 1,000 shares of a stock that I think is undervalued, and want to hedge against market (systematic) risk by shorting the SPYS. How do I determine how many shares of SPY to short against my long stock position? Do I need to consider the price of the stock versus the SPY stock's beta, correlation, or average daily range? Or is it based on something else? Every stock tends to move a different amount when the SPYS move a certain percentage. Shouldn't that be factored in? It seems that just keeping the dollar amounts the same isn't enough. Any help would be appreciated. -- Matthew
I don't recommend hedging with SPYS (S&P 500 Depositary Receipts trust series) in the first place. For a portfolio (correlated basket), sure, but not for a single stock. When attempting this, you simply take away the reward, and still keep the risk for the most part. This is an example of overcomplication -- you're better off trading the stock than hedging it.
Trading is simple: If you feel the stock is undervalued, buy it. Just try to match up the dollars as close as you can; you'll never be able to weight it properly, since it's impossible to have a stock hedge directly to the overall market. We trade around a core position, like the 1,000 shares you talk about. When the market goes down intraday, you can hit bids and buy it back several times. Then you keep it in your portfolio, since the market averages 10% per year historically.
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the December 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
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