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July 1, 2013

Q. I’m learning about pairs trades, and I loaded up 30-year bond futures vs. 10-year note futures ( /ZB - /ZN) on the thinkorswim® Charts. If the price on the chart goes from say, \$14 to \$15, what does that mean in dollars?

A. Whenever you’re looking at a pair of symbols on a chart, you’re looking at the difference in their prices. So, for the /ZB - /ZN chart, the price of /ZB minus the price of /ZN was \$14. To figure out what a move from \$14 to \$15 means to calculate profit/loss, for example, you have to know what the point value is of the symbols you’re looking at. For both /ZB and /ZN, the value of 1.00 is \$1,000. So, if /ZB rises 1.00 more than /ZN, or /ZN drops 1.00 more than /ZB, the difference will rise to \$15. The 1-point change in that pair is equal to \$1,000 of value. Now, if you’re looking at two stocks where 1 point is equal to \$1.00, a change in the pair from \$14 to \$15 would simply be equal to \$1.00. And if you bought 100 shares of one stock and sold 100 shares of the other, the 1.00 would be equal to \$100.

Q. Do you use trading days or calendar days in your calculations on thinkorswim?

A. In the calculations for the greeks and probability numbers, for example, we use calendar days to expiration and 365 days in a year. That said, you might like to look at trading days to expiration and 262 trading days a year. The important thing is to use one approach consistently. Don’t go back and forth. If you do that, it will be much harder to estimate why a greek or probability number changed due to the stock price, time passing, volatility, etc. Incidentally, for you math nerds out there, the option formulas usually use the square root of time. The square root of 30 calendar days divided by 365 is .2866. The equivalent trading days of 20 divided by 262 is .2763. Practically speaking, that’s not a big difference.

Q: Can a long (debit) vertical spread ever have positive time decay?

A: When we think of long options spreads, we usually think of negative time decay (time passing working against you). And that’s certainly the case for long out-of-the-money verticals for example. But when the vertical has its long option in the money and short option out of the money, it might have positive time decay (time passing working for you). If the debit of this type of at-the-money vertical is less than the intrinsic value of the long in-the-money option, time decay is positive. The reason is that if the stock stays at its current price at expiration, the value of the vertical will be worth the intrinsic value of the long option. It will grow from its debit to the intrinsic value at expiration. That growth is, in my book, positive time decay.

Q. Do you wear a lucky hat or tie or underwear when you trade?

A. I don’t buy into superstition but please excuse me while I turn around three times before I route this sell order.