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 |
SWEEPS ON THE NYSE HYBRID
I 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 and then hits it on a sweep, or have trigger points already entered to take advantage of a sweep." You also mentioned you were working on a program called TapeReaderPro. Are you finished?
I don't know about you guys, but my scalper friends and I are struggling anyway. Thanks for being a leader in our business. --Steelhead
First off, thanks for the kind words. I have made comments about the state of the scalper these days on several occasions. Scalping alone is finally becoming a thing of the past. We will always do it, but not as the primary focus. Market efficiencies have increased, but other doors have opened for the daytrader -- we all need to adapt.
Some of our guys have triggers that are set off when the REDI quote line changes color, indicating a sweep or some other significant action is 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 test them, we may make them available to our traders.
TapeReaderPro is still being tested, so we'll be making some changes to it for 2007 before any big release.
We have advanced classes coming for our traders just to be sure that all the profitable methods are available and understood by everyone. So often, traders are reluctant to admit they're struggling with something, and it's easier just to show them how they might consider modifying their strategies.
Personally, I'm making more money since the hybrid, even though I don't have the privilege of trading all day (pairs with triggers, mostly).
STOCK OPTIONS AND SPLITS
I have read a lot of your answers, and I'm curious. How would you play the options on a stock split when they arise? --jllm03
I really wouldn't bother since all the floor traders have the stock split already accounted for on the theoretical models. Option strike prices will be modified (or number of convertible shares altered) anyway. In the good old days, we would simply assume the stock would rise slightly after the stock split and play the options accordingly. Our reasoning was that if a $100 stock became a $30 stock, then more people would be able to buy shares. Worked back then, not so much these days.
FAIR VALUE FOR TRADING
Could you provide me with detailed information on hedging by selling futures contracts at a premium to fair value, and buying the underlying securities? I am new to futures and have beginner to intermediate knowledge of equity trading. --Scott Rohner
Welcome to the world of futures, fair value, and index arbitrage. There are things you need to be aware of when using premium/discount to fair value for trading. For calculation specifics, you can check Hank Camp's site (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 derive the same risk/reward by buying the futures contracts on the Chicago Mercantile Exchange. You don't receive dividends on the futures, so that number is deducted from the fair value calculation. You do, however, have a much lower cost of carry with the futures since you aren't "spending" all that money to buy the underlying stocks. These concepts are the foundation for fair 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 traders tend 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 underlying stocks. Some have programs to buy all 500 stocks. This, in effect, is like buying at the exact parity price (price of all the stocks), and selling short at a higher price with the futures. They then wait for a turnaround in the market (seconds to minutes at times), and reverse the transaction by buying the futures at a discount to fair value and selling back all the stocks. They account for the costs involved, of course. This is the simplest form of futures arbitrage.
We watch the premium/discount all day to determine immediate market direction. Basically, we assume that if there is a big premium to fair value 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 fair value since we assume the arb traders will be selling at that particular moment. 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 these
minor market disparities. We spend quite a bit of time with these concepts
in 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 Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
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