Well, after finding this forum a month ago, I finally set up an account. Reason being, I kept getting errors trying to view the last page, and no one had properly answered the question on the first 3. Don gives a accurate but very brief description. I only intend to add depth. I'll tackle the conversion first, using IBM as the example, currently offered at 88.58. The Jun 90 calls are bid 3.10 and the Jun 90 puts are offered 4.80 The "cost" of the conversion is $0.28 per share, calculated as follows: outlay 88.58 for stock receive (3.10) for call outlay 4.80 for put Net 90.28 cost less (90.00) value at expiry price 0.28 for 'privelege' of being able to short on a downtick In reality, you would ask for a quote on the conversion, which might be '$0.05-0.20' in this case. You can sell the position for a nickel, or buy it for 20 cents per share. If you sell the position to open, you have a 'reversal' - the only people I know who do 'reversals' are the traders with huge capital taking the other side of your buy. Now once you have the position, and you want to be short IBM, you just sell your long stock without regard to an uptick. What you have left is a short call/long put - also known as a 'synthetic short'. If IBM goes up, you are losing money because both option positions are going against you, and you do not own the stock. T keep in mind this does tie up capital. I only did these in my firms' account, so I do not know the true buying power reduction, but I imagine it could be large. For 500 shares in the IBM example, the outlay is $45,100 (500x$90.20). I do remember getting hit with interest costs for carrying the position too, so there most likely was some margin component to it. (If you really need to know what the true costs are, I would think Don could give that number) a "bullet" is the common name for a Married Put. If you have a married put, you are long the stock, and long a deep in-the-money put. For IBM, you might have bought the stock at $88.58 and bought the May 140 put for $51.53. Most of the time, however, you deal with a market-making firm that writes a custom put for you, and your only cost is their commission. My recollection is about $50 for a 2500 share "bullet". These custom puts typically expire at the end of the day you enter the transaction. In either case, conversion or bullet, you 'go short' by selling long stock, and holding an option postion that increases in value when the stock goes down (and loses value if the stock goes up). The advantage to conversions and bullets is that you don't have to comply with the short-sale rules, because you are not short the stock. WHOA! NOT SO FAST. If you did a 500 share conversion or bullet for IBM, and wanted to be short 1,000 shares, you can not enter an order to sell 1,000. You have to do one of two things: Mark the entire ticket SELL SHORT; or, make 2 tickets- Sell 500 on the first ticket, and SELL SHORT 500 on the 2nd ticket.
What joy it will bring to many traders if the short sale uptick rule is ever abolished, thereby not needing bullets or conversions ever again.
It is usually not cost effective for a retail trader to carry conversions in their accounts for the purpose mentioned above. I think "less active" did a good job with the overall explanation. When you trade the same stock 20-30 times per day, both long and short, the cost of a conversion pays for itself immediately. Don
I'm a Naz scalper and I agree with this statement wholeheartedly. Sitting around waiting for an uptick sucks when your stock is tanking hard and you want to get in. By the time you finally get one the run is often over. Frankly, it's a stupid rule anyway. What purpose does it serve? If everyone wants to sell really badly, the uptick rule certainly won't stop a stock from collapsing.
The only reason the uptick rule exists is because FEAR is a stronger emotion than GREED ! Oh, that and the fact that it allows MM's to jack you around when you are trying to execute off the level II.
Actually...you can thank J.P.Morgan and the other Robber Barrons of the 1920's for the uptick rule. prior to the crash of '29 they would force down the price a stock in a company that they wished to acquire by massive short selling then swoop in and buy the controlling interest. This behavior was one of the contributing factors leading to the crash and the creation of the SEC. Whether it works or not....I'm not sure.
I did mention that conversions do tie up capital, but Don hit it right on the head about it is generally not for retail accounts. I would put a conversion on a stock that I was active in on a daily basis, not necessarily to short it everyday, but to have it available if I wanted to. I would use a bullet for a stock that I didn't trade regularly, but wanted to short on a particular day. It took me a few weeks to get used to trading with a conversion. You have to learn when to hit the bids and when to sell into a rally. If you can't make money being short without a conversion or bullet, don't think that you will be able to make money constantly with a conversion. To give it a try, trade the DIA, SPY, or QQQ. These vehicles are up-tick exempt. One additional consideration: If you have a conversion/bullet for 500 shares and mark a ticket "sell short" and sell 500 shares into a rally, you have sold your long stock. You cannot mark a ticket "sell" for 500 shares against your conversion stock. Even when I trade from the long side, if I put a sell order in above the market, I always mark it "Sell Short". That way, if I decide to hit a bid while that order is out there and the market moves before I can update the original above-market order, I know I won't have a SS violation. As far as the "purpose" it serves, I think it is only to discourage retail investors from going short. If you understand any of this thread, you have already realized that professional traders can work around the short-sale rule. Remember when you put on a conversion or bullet, unless you leg into it, the other side of the trade is a market maker. These folks are exempt from the short sale rule (provided it is done as a "dealer" and not in the firm's "investment" account). To give you and example, one of the "best" traders in the firm I was with decided to get a bullet on a stock that just announced some bad news before the open. Although he was typically quiet, this day he shouted his order to the bullet firm. Everyone heard it, and had a transaction value of about $4MM. The net change from the opening print to the closing print was -7.5%. One of the other traders commented to him how he must have cleaned up on that one. His reply: I sold a couple thousand shares to test the market, it ran straight up 3 bucks on me, I covered and never looked at it again the rest of the day. I happened to be standing next to him when he said this, and although I only made in a year what one of his good days were reported to be, I had to ask him: "Do you ever think what the other side is doing?" He looked at me quizzically, and I continued - when you call up the bullet firm, they are getting a whole lotta other calls. They have a good idea how many shares of bullets are done, and they have guys on the floor at the NYSE who have got to know how much is institutional and retail volume. If they think they do 25% of the bullet business, and they did 2MM shares of bullets, once they get an idea that over 7MM of volume is bullet trading, might they come in and buy, to try and shake some people out? His reply - "I never thought about that...interesting" People always complain about how market makers "jack" people around. These guys provide liquidity, and no one is going to do it if they don't have an edge that allows them to be paid for taking the risk.
Good points about the bullets (and the firms who sell them, as well as the traders who use them). We are obviously friends with our bullet provider, and even though they get a lot of "information" they cannot really profit from it. Since every bullet that is used, another person is buying an equal number of shares. As you pointed out in your post, sometimes just a small share "test" can save you a lot of money....even though he may have lost on that particular trade, just having the access to bullets allowed him to test properly. Trading is simple...and we "simply" enter a great number of trades with the intention of making morey than we lose....and "testing" is a big part of it. Don
Yep. I don't think someone could get a capital account large enough to make a 4MM decision in a second if he/she didn't know how to "test" if first. That is also why I suggested to those considering thest that they test their abilities with some up-tick exempt securities. The thread starter didn't sound like he traded at a firm that has access to bullets. My recollection is that a bullet for up to 2,500 shares is $50-75 commish. Don, perhaps you could enlighten us if that is accurate/high/low? and perhaps even give an estimate of the monthly carrying cost of a 1,000 share conversion on a 45 dollar stock? One good trade with them does cover these costs!