Q&A
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 |
PROGRAM TRADES
I read an online chat that talked about programmed trades occurring
on the Nasdaq. I don't trade that market, but found it interesting. It
made me wonder, with more than 50% of NYSE volume in programs, whether
it is important to investigate that process and learn more about it. Currently,
I am knowledgeable with regard to index arbitration (program trades that
work the premium), but know little about other types of program trades.
To what extent does your training deal with that subject? I am hoping to
find a resource for learning more about the subject generally. I appreciate
any comment you might have. -- Steve
First, we have to define program trades. There is the legal definition,
which has rigid guidelines and is subject to trading curbs and other restrictions.
I prefer the broader definition, which includes any type of automated response
to the market via programming. This takes on many forms, from simple, if/then-type
DDE-link (dynamic data exchange) activated or ActiveX responses, to elaborate
massive line item order entries using FIX protocol.
I have mentioned Hank Camp a few times, and you might want to check
out his website at: www.programtrading.com (for the more technical applications).
Our group in Canada, PairCo, has several elaborate programs for various
types of trading. Pair trading is obviously a big focus for them, but they
have quite a few other strategies that they have automated. There are black
box-type programs that can simply be left running (not advisable for most
people), and hybrid black-box programs that require a lot of monitoring.
You can find out more about this at www.pairtrader.com. These experts grace
the Bright Trading training grounds at virtually every advanced session.
PLACING OPENING ORDERS
How do you place opening orders for stocks that have a premarket
indication? For example, yesterday KSS closed at 48.74. This morning, it
was indicated at 49.50 low, 50.00 high. Would you set an envelope around
an average of these (49.75)? Thanks. -- James
I would only move the offer up (you never want to buy a stock in the
lower end of a much higher gap opening). Leave the bid alone, and place
the offer at 49.75 or so (top half or top third of the indicated range).
COMMODITY OPTIONS
I am a novice to commodity options trading. Would you explain a trade
using grains as an example, including the potential risk, gain, and cost?
-- Louis
For the most part, options are traded pretty much the same way regardless
of the underlying security or commodity. Options are valued based on volatility,
time until expiration, and interest rates (called cost of carry). There
is a fundamental difference between options traders. Some of them are risk-averse,
and therefore they want to buy puts or calls. This way, their loss is limited
to whatever they paid for the options (this is called the premium). This
side generally consists of retail speculators. The other side, which includes
most floor traders and other professionals, like to sell this premium to
collect time decay. Every day that goes by, the option is worth a bit less.
Many options simply expire worthless, so the profit is based on whatever
price they sold for. It is more risky to sell options, because the underlying
commodity has an infinite possibility of moving up in price. However, if
you have a full understanding of the options, futures, and other instruments,
then you can hedge your positions in a myriad of ways. As with most things,
being able to hedge with cross-market instruments is a big edge.
Rather than take the whole page here, I'm going to give you a site that
I happened across on the web: FuturesBasics.com. I don't know these people,
but their basic explanation is clear and concise. You can search the site
for examples of trading options on corn.
HEDGING SPYs
Suppose I buy 1,000 shares of a stock that I think is undervalued,
and want to hedge against market (systematic) risk by shorting the SPYS.
How do I determine how many shares of SPY to short against my long stock
position? Do I need to consider the price of the stock versus the SPY stock's
beta, correlation, or average daily range? Or is it based on something
else? Every stock tends to move a different amount when the SPYS move a
certain percentage. Shouldn't that be factored in? It seems that just keeping
the dollar amounts the same isn't enough. Any help would be appreciated.
-- Matthew
I don't recommend hedging with SPYS (S&P 500 Depositary Receipts
trust series) in the first place. For a portfolio (correlated basket),
sure, but not for a single stock. When attempting this, you simply take
away the reward, and still keep the risk for the most part. This is an
example of overcomplication -- you're better off trading the stock than
hedging it.
Trading is simple: If you feel the stock is undervalued, buy it. Just
try to match up the dollars as close as you can; you'll never be able to
weight it properly, since it's impossible to have a stock hedge directly
to the overall market. We trade around a core position, like the 1,000
shares you talk about. When the market goes down intraday, you can hit
bids and buy it back several times. Then you keep it in your portfolio,
since the market averages 10% per year historically.
E-mail your questions for Bright to Editor@Traders.com,
with the subject line direct to "Don Bright Question."
Originally published in the December 2004 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2004, Technical Analysis, Inc.
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