V. 19:11 (62): Q&A by Don Bright

Q&A by Don Bright

SINCE YOU ASKED

Professional trader Don Bright of Bright Trading, an equity trading corporation, answers a few of your questions.

INDEX ARBITRAGE

Don, I have enjoyed your commentaries in STOCKS & COMMODITIES. Can an individual buy a “basket” of stocks economically enough (say with your firm) in order to perform index arbitrage: selling futures versus buying cash and vice versa? “Spread trading” or hedged strategies appeal to me; what valid spreads do you teach or trust, and can an individual perform S&P or E-mini arbing almost as effectively as the floor traders or market making firms? Thank you. — David Pfizenmaier

You’ve brought up a couple of interesting ideas about arbitrage methodology. If your costs are low enough as you mentioned (trading with a proprietary firm), then you can do very well trading baskets of individual stocks vs. a futures contract. With point-and-click trading and by using links to the exchanges or electronic communications networks (ECNs), a trader can almost simultaneously execute orders upon finding a discrepancy in pricing. That covers the tactical aspect of performing the functions necessary.

Now for the strategic aspect of these methods. Hedge baskets can range from a handful of high-cap stocks to the entire Standard & Poor’s 500, for example. A good arb trader will find a proper sampling that will reflect the larger index, but this is not easy. You will find that oftentimes adjustments are needed based on news items, earnings warnings, and so on. Our traders don’t generally hedge with the futures, preferring to use them instead as immediate indicators to tell which side of the pair trade or spread trade they want to open first. Thanks for reading the column, and thanks for the kind words!