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Ask Trader Guy: Market Advice On Fills, Futures And Spreads

January 1, 2013
Limit Order Option Spreads
Fredrik Broden

Q: If I'm working a limit order to open an option spread position and I don't get filled, should I change my limit price to get filled?

A: If you're working a limit order at the mid-price, or average of the bid/ask price of the spread, you could adjust it up a bit if you're buying, or down a bit if you're selling. But when you do that, you're increasing slippage—the difference between the bid/ask price. With actively traded stocks and options that have bid/ask spreads only a few pennies wide, you can often get filled .01 away from the mid-price. That's not bad. If you have to move the limit price more than that to try to get filled, you may want to skip it, and find another product where you could get filled closer to the mid-price. If someone doesn't want to play with you, take your ball and move to another playing field.

Q: I'm short an option that's far out of the money, and it should be getting cheaper as it approaches expiration. But my P/L isn't changing at all. What gives?

A: You're right. Theoretically, the short out-of-the-money option should be getting cheaper as time passes, if the stock price and volatility don't change. More, the p/l of your position is based on the trade price, and the average of the current bid/ask spread. I'm guessing that far out-of-the-money option probably has a 0.0 bid, and .05 ask, which makes the mid-price .025. If the bid/ask doesn't change, the p/l won't change. So, even if the theoretical value of the short option drops from .02 to .01, if the market makers for that option keep the bid/ask 0.0-.05, your p/l won't change. In that case, the p/l would reflect all that remaining .025 at expiration, if the option does indeed expire worthless.

Q: I know that in general, when interest rates move up, bond prices go down, and vice versa. But, is there a way to know how much the price of a bond future changes when interest rates change 1 basis point?

A: The relationship between bond prices and interest rates is non-linear, so this approximation works when bonds and rates are at about their current levels. If the yield on the 30-year Treasury moves up or down 1 basis point (.01%), the bond future changes about 5 ticks. If the 30-year yield changes 100 basis points (1%),the bond future changes about 17 points. To get the price of the bond future to change 1 point, the yield has to change about 6 basis points (.06%).

Q: I'm only 13 years old, so I don't know if you'll take this question, but I was thinking about buying a put on my next math quiz score. It would be a hedge against the Wrath of Mom if things don't go my way. Care to make a market?

A: Kid, I like the way you think. But my answer is no, for three reasons. First, it's probably illegal. Second, you could intentionally throw the quiz and drive the puts in the money. Third, I trudged through middle-school math and look what I turned out to be! You have to suffer like everybody else.

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