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that divergence is what stock index traders seek |
when it occurs the traders place orders via computers to buy the basket of stocks such as the N stocks that constitute the standard & poor 's N stock index in whichever market is cheaper and sell them in the more expensive market they lock in the difference in price as profit |
such program trades which can involve the purchase or sale of millions of dollars of stock occur in a matter of seconds |
a program trade of $ N million of stock typically earns a <unk> profit of $ N |
to keep program-trading units profitable in the eyes of senior brokerage executives traders must seize every opportunity their computers find |
the speed with which such program trades take place and the volatile price movements they can cause are what program trading critics <unk> to <unk> |
if you continue to do this the investor becomes frightened any investor the odd <unk> mutual funds and pension funds says larry <unk> managing partner at neuberger & <unk> |
but many experts and traders say that program trading is n't the main reason for stock-market gyrations |
i have not seen one <unk> of evidence to support restrictions on program trading says a <unk> university finance professor <unk> stoll an authority on the subject |
says the big board 's mr. phelan volatility is greater than program trading |
the oct. N plunge was triggered not by program traders but by news of the <unk> of the $ N billion buy-out of ual corp |
unable to unload ual and other airline shares takeover-stock speculators or risk arbitragers dumped every blue-chip stock they had |
while program trades swiftly kicked in a circuit breaker that halted trading in stock futures in chicago made some program trading impossible |
susan del <unk> head trader at travelers investment management co. says critics are ignoring the role the takeover stock <unk> is taking in the market as a source of volatility |
many <unk> are <unk> she says and they have to sell when things look like they fall apart |
like virtually everything on wall street the program-trading battle is over money and the <unk> have been losing out on <unk> of it to the new guard in recent years |
take the traditional money managers or stock pickers as they are <unk> known among the computer <unk> |
traditional stock managers like to charge N cents to N cents for every $ N they manage for big institutional investors and higher fees for smaller investors |
yet many such managers consistently fail to even keep up with much less beat the returns of standard <unk> like the s&p |
not surprisingly <unk> money managers have been losing clients to giant stock-index funds that use computers to <unk> portfolios so they mirror the s&p N |
the <unk> charge only a few pennies per $ N managed |
today about $ N billion or N N of all <unk> stock investments is held by index funds |
the new wall street of computers and automated trading threatens to make <unk> of the N big board <unk> firms |
these small but influential floor brokers long have earned fat returns of N N to N N a year on their capital by virtue of their monopoly in making markets in individual stocks |
the specialists see any step to electronic trading as a death <unk> |
and they believe the big board under mr. phelan has abandoned their interest |
the son of a specialist and once one himself mr. phelan has nonetheless been <unk> with products like the new stock basket that his former colleagues dislike so much to keep index funds and other program traders from taking their business to overseas markets |
meanwhile specialists ' trading risks have skyrocketed as a result of stock-market volatility |
when the sell programs hit you can hear the order printers start to go on the big board trading floor says one specialist there |
the buyers walk away and the specialist is left alone as the buyer of last resort for his stable of stocks he contends |
no one is more unhappy with program trading than the nation 's stockbrokers |
they are still trying to lure back small investors spooked by the N stock-market crash and the market 's swings since then |
small investors are absolutely <unk> that wall street is <unk> the deck against them and these wide swings are scaring them to death says raymond a. mason chairman of regional broker legg mason inc. in baltimore |
stockbrokers ' business and pay has been falling |
last year the average broker earned $ N N N lower than in N |
corporate executives <unk> that their company 's stock has been transformed into a <unk> piece of a stock-index basket |
index traders who buy all N stocks in the s&p N often do n't even know what the companies they own actually do complains andrew <unk> chairman of champion international corp |
do you make <unk> or <unk> |
oh you 're in the paper business is one reaction mr. <unk> says he 's gotten from his big institutional shareholders |
by this september program traders were doing a record N N of the big board 's average daily trading volume |
among the top practitioners were wall street blue <unk> morgan stanley & co. kidder peabody merrill lynch salomon brothers inc. and painewebber group inc |
but then came oct. N and the negative publicity <unk> by the old guard particularly against index arbitrage |
the <unk> ' strategy for the moment is to <unk> down and let the furor die |
there 's a <unk> psychology right now says the top program-trading official at a wall street firm |
wall street 's cash <unk> has been <unk> but i do n't think anyone has proven that index arbitrage is the problem |
too much money is at stake for program traders to give up |
for example stock-index futures began trading in chicago in N and within two years they were the fastest-growing futures contract ever launched |
stock futures trading has <unk> dozens of <unk> in their <unk> and <unk> |
now on a good day chicago 's stock-index traders trade more dollars worth of stock futures than the big board trades in stock |
now the stage is set for the battle to play out |
the <unk> are getting some helpful <unk> from congress |
program traders ' power to create total panic is so great that they ca n't be allowed to have their way says rep. edward markey a massachusetts democrat |
we have to have a system that says to those largest investors |
sit down |
you will not panic |
you will not put the financial system in jeopardy |
but the prospects for legislation that targets program trading is unlikely anytime soon |
many people including the big board think that it 's too late to put the <unk> back in the bottle |
the big board 's directors meet today to approve some program-trading restrictions but a total ban is n't being considered big board officials say |
you 're not going to stop the idea of trading a basket of stocks says <unk> 's prof. stoll |
program trading is here to stay and computers are here to stay and we just need to understand it |
short of a total ban some <unk> have proposed several <unk> reforms which they say would take away certain advantages program traders currently enjoy in the marketplace that other investors do n't |
one such proposal regarding stock-index futures is an increase in the margin requirement or the <unk> payment of cash needed to trade them to about the same level as the margin requirement for stocks |
currently margins on stock futures purchases are much lower roughly N N compared with N N for stocks making the futures market much faster and potentially more speculative |
program trading critics also want the federal reserve board rather than the futures industry to set such margins |
futures traders respond that low margins help keep their markets active |
higher margins would chase away dozens of smaller traders who help larger traders buy and sell they say |
another proposed reform is to have program traders answer to an uptick rule a reform instituted after the great crash of N that protects against stocks being <unk> beaten downward by those seeking to profit from lower prices namely short sellers |
the big board 's uptick rule prevents the short sale of a stock when the stock is falling in price |
but in N program traders received what amounted to an exemption from the uptick rule in certain situations to make it easier to link the stock and futures markets |
a <unk> of the uptick rule for program traders would slow their activity considerably |
program traders argue that a <unk> of the rule would destroy the pricing efficiency of the futures and stock markets |
james a. white contributed to this article |
<unk> <unk> |
big board chairman john phelan said yesterday that he could support letting federal regulators suspend program trading during wild <unk> swings |
thus the <unk> psychology of recent days picks up new impetus |
index arbitrage is a common form of program trading |
as usually practiced it takes advantage of a rather basic concept two separate markets in different locations trading basically the same <unk> ca n't trade them for long at prices that are widely different |
in index arbitrage the widget is the s&p N and its price is constantly compared between the futures market in chicago and the stock markets largely in new york |
to profit from an index-arbitrage opportunity someone who owns the s&p N widget in new york must sell it and replace it with a cheaper s&p N widget in chicago |
if the money manager performing this service is being paid by his clients to match or beat the return of the s&p N index he is likely to remain fully invested at all times |
few if any <unk> managers will risk <unk> performance by owning more than N N exposure to stocks and equally few will want to own less than a N N position should stocks rise |
by constantly seeking to own the cheapest widget index-arbitrage traders hope to add between N N and N N to the annual return of the s&p N |
that represents a very thin excess return certainly far less than what most fundamental stock pickers claim to seek as their performance objective |
the fact that a vast majority of <unk> money managers fail to beat the s&p N may contribute to the <unk> surrounding the issue |
as more managers pursue the index-arbitrage strategy these small opportunities between markets will be reduced and eventually eliminated |
the current opportunities arise because the process for executing a buy or sell order in the actual stocks that make up the s&p N is more <unk> than <unk> in the futures market |
the new york stock exchange 's attempt to introduce a new portfolio basket is evidence of investors ' <unk> to make fast and easy transactions of large numbers of shares |
so if index arbitrage is simply taking advantage of thin <unk> between two markets for the same widget how did program trading <unk> into the evil <unk> that is <unk> the <unk> of so many observers |
all arguments against program trading even those pressed without fact conclude with three expected results after reforms are implemented N reduced volatility N a long-term investment focus and N a level playing field for the small investor |
but many of these reforms are <unk> even harmful |
reducing volatility |
an index-arbitrage trade is never executed unless there is sufficient difference between the markets in new york and chicago to cover all transaction costs |
arbitrage does n't cause volatility it <unk> to it |
think about what causes the difference in prices between the two markets for s&p N stocks usually it is large investors <unk> a buy or sell in chicago |
a large investor will likely cause the futures market to decline when he sells his futures |
arbitrage simply transfers his selling pressure from chicago to new york while <unk> as a buyer in chicago |
the start of the whole process is the key someone must fundamentally increase or decrease his ownership in <unk> to make widget prices move |
why does this large hypothetical seller trade in chicago instead of new york |
perhaps he is willing to sacrifice to the arbitrage trader some small profit in order to get quick and certain execution of his large trade |
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