By Thomas Stridsman and Mark Etzkorn Y ou hear about it every day on TV, you read about it all the time on various Web sites. Of course, we re talking about program trading and fair value, two of the most commonly referenced and misunderstood concepts in trading. If you watch one of the financial networks or news shows on any given morning, you re likely to be told the fair value is 5.75 and, based on that, hear a projection about what is likely to happen when the market opens for trading. Later in the day, especially if the markets are really moving, you might hear references to buy programs or sell programs that are pushing prices higher or lower, or learn that trading curbs have been put in place by the exchanges. To answer these questions, we first need to get a basic handle on what program trading is all about and what fair value really is.
Program trading can take many forms.
You ve exploited an inefficiency in the market for used Ford Tauruses. If these two parties were aware of each other, their bids and offers would likely be much closer and there would be no inefficiency to take advantage of or it would be too small to be worth the bother. According to the NYSE Web site, program trading accounts for 20 percent of the exchange s daily volume. Trading stocks against futures is referred to as index arbitrage , and this is what most people think of when they hear about program trading. But there are a number of types of trading programs that do not fall into this category.