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
|
PAIRS TRADING
I read your article and your Q&A section in STOCKS & COMMODITIES
this month. In both, you referred to "pair trading." When I read
that it was a strategy used successfully by your niece, I was intrigued.
Would you please explain the strategy? - Scott Memmott
Many of our successful traders use one form or another of a "pairs"
trading strategy. There has been quite a bit of research into the subject,
and even an article in a previous issue of S&C. Let's start with the
basic premise: Many stocks within the same or similar sectors tend to "track"
one another - that is, they show correlated historical pricing. Let's take
an example that we traded a year or so ago, Merck (MRK) and Lilly (LLY).
Both are pharmaceutical stocks, and both are highly capitalized Standard
& Poor's 500 index stocks.
If you run a simple price chart back a few years, you will see that
they have crossed the same price several times. Traders can sell the higher-priced
stock and buy the lower-priced one and then close the positions when they
are at the same price. This is a simplified explanation of the basic concept.
Traders tend to employ overall market conditions and timing, intraday,
to find a good entry point for the stock that they feel will move first.
They will initiate this trade if and only if there is a bid (or offer)
that they can "lean on" in the other security. Say they buy LLY
when it is lower than MRK; then if LLY does not move in the direction anticipated
in a short time frame, or goes against them, they will sell MRK on the
bid to "hedge" themselves. At this point they have essentially
"sold" the pair (since they have sold the higher-priced stock)
at a given price, say $5.00.
Next, they mark that as a single trade like this: Sold LLY/MRK at $5.00.
Now they will either repeat the process at maybe $5.50 (adding to the position),
or cover the original at a profit, say $4.50. By trading, rather than holding,
they can pull many points out of a small price range. If the pair were
to trade in a channel between $4.00 and $6.00, you could trade in and out
in much the same way you trade support and resistance in a single stock.
There are many more advanced variations on the strategy, but this should
give you a good idea of what I am referring to. Glad to help, and keep
reading the articles!
SINGLE STOCK FUTURES
Don, do you know what stocks will have single stock futures and
also on which exchanges these instruments will trade? - Vinny1
As of this writing there is still some squabbling going on between the
various exchanges about who will list what, who will have a primary market
(if anyone), and who will get the choice issues. I think we will not see
any actual trading for a few months. I am writing an article about the
potential trading strategies and how single stock futures may affect both
the equities markets and the index futures markets.
As I said before, there are some obvious events that will transpire,
and I will touch on them, but I am trying to focus on the more interesting
concepts. If we simply use the basics of dividend yields and interest rates,
we see some cool plays on the horizon. When we add "basket exchanges"
and pairs trading to the mix, we should see some nice techniques evolve.
Stay tuned.
INTRADAY SPREADS
I have looked at chart after chart of AOL/VIA and a few other
pairs I track. How exactly do you trade a spread intraday? Can you give
just one example on why you took a trade? I spend a lot of time looking
at how I can possibly make use of a pair relationship, and I really need
just one example to link the pieces together. -Hitman
I watch AOL and VIA trade and see that the price differential has been
between $3.50 and $6.80. As the pair was rising in price, nearing $6.00,
I sold VIA short when I saw the overall market weakening, and repurchased
it at a lower price - several times. This is the "hard" side
(since you have to sell short unless you buy bullets or have a conversion),
and when I wasn't able to buy VIA back (say the market reversed and the
VIA spread widened to the upside), I would buy AOL, thus "selling
the spread" for around $6.00.
I repeated this a few times (both the intraday selling short and covering
and the adding to the overall position). I ended up with three units (at
2,000 shares each) of the spread. I sold it at $5.80, $6.31, and $6.88,
if I recall. Now we reverse the logic when the differential starts to narrow.
I purchased the spread that I sold for $6.88 for $6.25 and the $6.31 and
$5.80 for around $5.00 or so (sure, I could've waited for a better price,
but the spread could just as easily have begun to widen again). It's a
very simple strategy, but it does take some time to execute properly and
requires applying an envelope of buy and sell orders all day long.
FELONS
Can a felon convicted of a conspiracy charge related to drug trafficking
and money laundering obtain a license to trade a proprietary account? If
you do not have an answer, would you be able to direct me to someone who
may know the answer or where I could research this information? Thank you.
- A.K.
I passed this question to our compliance officer, and received the following
response: "Anyone with any felony conviction is subject to a statutory
disqualification for 10 years after the date charged. We cannot accept
anyone with an SD into the LLC."
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 March 2002 issue of Technical
Analysis of STOCKS & COMMODITIES magazine. All rights reserved. ©
Copyright 2002, Technical Analysis, Inc.
Return to March 2002 Contents
