Q&A
Since You Asked
| Professional trader Don Bright of Bright Trading, an equity trading corporation, answers a few of your questions. | 
Don Bright of Bright Trading |
MONEY MANAGEMENT OF OPTION SPREADS
What are some money management tips for credit and debit spreads? Specifically, when should I get out when a spread goes against me? - Bob Maclaurin
When you have a pure option spread in place, each option has a theoretical delta (percent equivalent to shares of stock; 100 delta = 100 shares of stock). So when a spread starts to go against you, you can do a few things. First, of course, you can get rid of it. Second, you can adjust your net delta position to near zero (plus or minus the amount of risk you want to take on the long or short side for market movements and individual price movements) by adding to or reducing the number of contracts involved. Third, you can adjust delta by using the "best"-priced options (based on theoretical valuations). For example, if you are losing on the long side due to short calls, consider buying some "far out" calls of a different strike price to compensate. These are some of the methods used daily by options traders on the exchanges.
NYSE OPEN BASED ON FUTURES
I'm a reader of your wonderful magazine and love many of the articles written about the technical aspects of trading. Currently, I'm interested in how to better trade the open of the New York Stock Exchange (NYSE) market. I would like to accurately determine how the market will open off the futures opening; I'm hoping to trade individual Dow stocks with more confidence. Thanks - Byron
You've asked a great question. We rely heavily on trading the NYSE openings for a couple of reasons. First, we like to be on the same side of the opening trade as the NYSE specialist, and second, we like making money (who doesn't?). This strategy has proven successful over many years, and now we even automate the process for many of our traders.
The basics of getting into the trade: Just prior to the opening bell in New York, we look to see where the futures are trading in relation to fair value (FV). I use the e-minis because they trade right up until the opening bell, giving an accurate reflection of where the markets will open. For example, suppose we feel the market should open up by 1% (based on the futures price versus the current day's fair value). We then "envelope" the expected opening prices of a group of stocks (I personally use about 20 large-cap stocks) by placing a bid below and an offer above the expected opening price. My envelope varies from 0.7% to 1.0% above and below FV.
Now, if the stock opens higher than my (short) sale price, then I will have sold it at that price (generally along with the specialist), and if it opens below or at my bid price, I will have purchased the shares.
Then we adjust the envelopes for betas, news, and the like. Some send in separate pricing for individual sectors as well.
Now comes the true art of tape reading: getting out of the trade! Since we are in at a good price, with the specialist we have a good chance of the stock going our way, at least for a short time. Some traders use stop-loss orders after the opening entry. I prefer to use "stop winners," meaning that I put in a closing order that will give me a quick profit of 15-25 cents on the trade. This is the "slingshot" effect. We then watch the tape for proper exit points.
PERCENT RETURN
What does the "percent return" on a trade really mean? Any help or thoughts would be much appreciated.-Richard K.
We (shorter-term traders) don't really use return on investment (ROI) to describe the amount of money we make. For example, if one of our traders has $25,000 in her account but makes $5,000 per week, is she really getting a 20% return per week? No, not really, because she may be using $500,000 (or more) of the firm's capital to make that money. Trading profits are return on labor, not capital, in my opinion. After you make a few million bucks, then you can worry about the ROI.
To answer your question more directly, I would simplify the whole thing to beginning capital, ending capital, and number of days/weeks in the middle to determine ROI (that way, your costs and commissions should be accounted for).
STOCK HALT
Suppose a stock halts, then opens with a wide gap down. How is that vacuum created? As I understand it, there must be thousands of orders and millions of shares. How do they vanish at the instant it opens? On several occasions, I wanted to short a few points lower than the closing price, but the stock opened with a gap down. Is there any sort of foul play in between when a stock halts and opens? Thanks. - Spark
When a listed stock is halted (ST or "stopped trading"), the specialist still accepts limit and market orders until the stock reopens. The reopening works just like every daily opening: the specialist matches up buys and sells to give the best price to the customers/traders. Stocks may be halted for several reasons, but usually it's because bad or good news has come out that will have a major effect on the stock. After a period of time, when the news has been digested by the public, the stock is reopened. This saves a lot of money and grief for most parties, since the buy orders that were already in will be filled at a much better price (with bad news out).
Don Bright is with Bright Trading (www.stocktrading.com), a professional equity corporation with offices around the US. E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the November 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.
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