Important Proprietary Trading Strategies

• Most proprietary trading involves arbitrage. Index arbitrage, statistical arbitrage, merger arbitrage and volatility arbitrage are all popular forms of trading. Groups of dedicated traders, separate from traders and salespeople dedicated to filling institutional orders, oversee trading activity. Because of the diminished use of 'open outcry' (trading on the NYSE floor through shouted-out orders rather than through computer matching of orders), arbitrage is done directly from institutional computers to computer-order placement on the exchange floor.
  
  

Potential Issues in Proprietary Trading Strategies

• It is incumbent on brokerage firms to respect the confidential information given to them by customers. A "Chinese Wall" prohibits information given by clients to be used by the brokerage firm for their own benefit. An example of the violation of trust between customer and brokerage firm would be 'front-running' of customer orders whereby banking firms buy stock before buying stock for customer orders. Yet there is no clear separation mechanism to prevent the knowledge of customer orders to be incorporated into the interests of the proprietary traders. Understand that, until recently, investment banking was considered a fee earning business with proprietary relationships a secondary concern. The use of proprietary trading to produce a major portion of a company's earnings is a relatively new development.
  
  

The Choice of Instruments When Proprietary Trading

• Trading occurs in stocks, bonds and futures. Positions are described as high frequency (arbitraging small differences between the stock or bond price and the value of an index, for example) or low frequency (buying a stock or bond position in a takeover candidate and holding the position until a deal is consummated). Because of the vast size and depth of the United States Treasury bond market, arbitrage is constantly under way. Trading consists of the carry trade (holding securities that have a higher income than the cost of funds needed to support the position), trading currencies to lower the cost of funding, option trading between stock and the premium of the option, and buying a futures contract and selling options on the positions for income while hedging the underlying futures contract.