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 |
CONVERSIONS
I understand that you were a trader on the options trading floor. Would you please explain what a conversion is? I have heard that they are risk-free. How can that be?--zdreg
First off, the basics are pretty simple. If you buy stock, say at $53, and sell $50 strike price calls and buy $50 strike price puts, then you have a conversion. If the stock goes up or down $10 (or any major move), you will not make or lose any money. The price of the calls and puts together will work out to be around $3.00 ($50 strike price, plus the difference between $50 and $53). The call and put together are your synthetic short position, and the stock is your long position.
Be aware that this is not a totally risk-free position. There is a small chance that the stock will close right at the strike price of $50, which may cause a problem. Since you are short the calls, you have no control over exercising them, which would pull stock away from you, thus altering your overall position. And since you don't know for sure if those calls are being exercised, you don't know whether you should exercise your puts. So theoretically, you could end up naked long or short the stock, which would cause market risk on the Monday after expiration day (third Friday of the expiration month).
The reason that some institutions and traders buy conversions is to either take a small mathematical edge from price disparities (pretty rare these days), or to have long stock in their portfolio that they can use to hit bids on downticks, resulting in profits when the stock goes down. If you have a conversion on and you sell 1,000 shares at $53, then buy it back at $51 (while keeping your calls and puts intact), you have made $2,000.
When I was on the trading floor, we loved doing the other side of this type of trade, the reversal or reverse conversion, because we enjoyed making money on the short stock sale portion of the equation. So conversions can be a win-win situation at times.
As always, be sure you understand options well before getting involved.
FILLING ORDERS
Is anyone else having trouble getting filled on listed stocks lately? It seems like every time I want to buy a stock, so does everyone else and the specialist just freezes the book, prints, and I don't get my fill. What do I have to do to get filled nowadays? Market orders? This is ridiculous.--Guru
Perhaps you're just getting better at reading the tape and the market. I've found over the years that our new traders get nearly 100% of their entered orders filled (because they may not be getting in at the best time). As they get better, they start getting filled on about half or less of their entered orders. If you're attempting to buy at a good time, then others are doing the same thing. Try placing your orders a couple of cents past the bid or offer - that might help.
PRICE IMPROVEMENT
I have a newbie question: What is price improvement? Why would they give us an improvement?
After you learn how DOT orders (direct order turnaround) are handled by the NYSE, then you will understand. An example is: Bid 20.04 - Offer 20.12. You enter a 20.12 bid, trying to buy 2,000 shares, and you get filled at 20.08 (quite a savings) because there is a broker in the crowd willing to sell at that price (but for various reasons doesn't want to show a lower offer).
OPENING INDICATIONS
I have read almost all your opening-only strategy threads, but I still have another newbie question: What is a stock's opening indication? And how can I see specialists' opening range estimate of certain stocks?
We use fair value calculations to determine our bid and offer prices. Opening indications come out before the opening if the stock looks like it's going to open more than about 35 cents away from the previous day's close.
FUNDAMENTALS OR TECHNICAL ANALYSIS
I have read through your website and most of your articles [in] Technical Analysis of STOCKS & COMMODITIES magazine, and yet you rarely, if ever, talk about technical analysis. Do you favor fundamentals? Is there something I am missing?--Kevin
I found out a long time ago that it takes much more than one technique/strategy/trading plan/set of indicators/ to make a living in this business. Our top traders are very aware of the technicals in their core stocks, and I personally post up the "numbers" (support, resistance, projected high/low, and pivots) every morning for our traders to see during our preopening squawk box session. Fundamentals have become increasingly important, especially since the bubble burst. With volatilities down, we hold positions longer, and wouldn't want to have a stock with a bad price to book ratio (compared to their peers and/or industry).
OPENING ORDER CRITERIA
How many stocks on your list [are] for opening-only orders? What's the criteria for the list? What envelope are you using these days with the Vix in the basement for so long?--Weasel
I still use only seven stocks, and I use between a 0.2 and 0.5 envelope with the volatility so low these days. The criteria hasn't really changed much. I use big-cap stocks, minimum of two million?share average daily volume. I have found over the years that you may have to switch a stock every now and then, but if you get used to how a stock trades in the morning, you'll have a much better feel for how to trade it.
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the March 2005 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.
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