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 |
CONVERSIONS
I'm new to options trading. Would you explain what a conversion is? -- Kelly, Cincinnati
"Conversion" means the buying of puts and selling of calls at the same price, and also buying the underlying stock at the same time. Conversions are critical to valuations, because although calls or puts may look overvalued based on historical volatility, interest rates, and so on (option modeling), they probably aren't when compared to the full "three-way." If you look at the call, put, and stock, you will find that the net pricing will be near fair value (again, based on interest rates, days until expiration, dividends, and so on). On the trading floor, traders will use the three-way valuation as a way to hedge themselves. For example: if I end up selling 200 calls at a good high price to the public, I can either buy other calls to hedge, sell puts, or buy stock, in order to get "delta-neutral." If I end up with too much gamma (short-term delta movement), I can compensate by completing a three-way to level out (again, just locking in profits from the call sales by being able to then turn around, buy the calls back, sell the puts, and sell the stock at fair value).
Reverse conversions, or "reversals," refer simply to the other side of the conversion. This is where the traders sell stock, sell puts, and buy calls so they can collect interest on the short stock sale.
TRADING JOURNAL
I look forward to your show every week on the radio, especially when you and Bob give away little tape-reading secrets! A few weeks ago Bob said something about only keeping a journal for about the first month or so. How come?
After a while, it just becomes a bit too time-consuming and distracting. It is great to continue the journal, with notes and analysis, when the trading day is finished, however. I had a very successful trader who claimed "I've never had a losing day -- look at my journal." I looked, and noticed some losing numbers. He explained, "I paid for some additional education once in a while, but I consider that money well spent." He went on to make a great deal of money, and I think the journal (with daily narratives and "objective" criticisms), along with his positive attitude, accounts for much of his success.
NYSE SPECIALISTS
I have recently switched to trading NYSE stocks. I have heard a few people suggest being on the same side as the specialist. In the normal course of trading, how do you determine which side the specialist is on? I trade large-cap stocks that follow the futures. Is there a way to determine if the specialist is participating in some of the large prints that go off, or at least a higher percentage chance the specialist would participate in those prints?
Also, I have noticed large block prints can do a few things. Sometimes the prints go off and the stock breaks out now that the buyer or seller is gone. In other cases it seems the stock is pushed to where the size is, the size is printed, and then it bounces back off that price level (stock is pushed down to 34, prints, and bounces to 34.15). Any hints how to figure out which kind of move you are going to get? -- downtickboy
It's pretty easy to figure out which side the specialist is trading, once you understand the rules. First, the specialist can only accommodate, not initiate, orders away from the current price. He or she cannot initiate either an uptick nor a downtick (except in special circumstances). Twice a day, on the open and the close (for opening-only and market on close [MOC] orders), the specialist will be on the opposite side of the imbalances. For example, if there are one million shares to buy before the opening, and only 800,000 shares to sell, the specialist will accommodate the order by selling shares at a higher price. The same type of thing happens at the end of the day for MOC orders. The difference at the end of the day is that the specialist will disseminate the order imbalances 20 minutes before the closing bell, looking for help in filling these extra orders. The specialist will restate the imbalance number 10 minutes before the close, as well.
Regarding the block prints: these are normally negotiated trades where the specialist temporarily "closes" the book by showing a 1x1 share bid and offer. He or she fills the buyers or sellers at a better price; this price improvement is oftentimes reversed. These are great trade-through plays that we endorse for our traders.
OPENING ORDERS
I have a quick question about opening orders. If your envelope for a stock is too wide based on the preopening indication for that stock, do you move your bid and ask to fit the indication? If so, do you do both sides, or just the side most likely to get filled? I am not sure if I should adjust my envelope to fit the indication on all the stocks, or just some stocks that are near my initial envelope. Thanks. -- Darren Vucurevich
I adjust to the lower (upper for sales) third of the indication only if the indication is "away" from my price (if I have a 30.50 bid, and the indication is 29.00-29.60, I will use a 29.20 bid, approximately). I won't tighten the bid/offer to reflect the indication, since I don't want to be filled within the fair-value range.
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the September 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
Return to September 2004 Contents