Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
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Calculating
With Treasury futures at or near an all-time high, I would like to begin trading options on bond and note futures but I am having difficulty calculating profit, loss, and risk.
Figuring in Treasury options often causes confusion for two primary reasons. First, both options and futures in Treasuries are traded in fractions. Second, unlike other commodities and financial futures, bond and note options differ in the manner in which they are quoted from their futures contract counterparts. Before you can understand how to calculate Treasury options, you must be comfortable with calculating in the corresponding futures contracts. Keep in mind that if you are capable of computing in Treasury bonds, you will be proficient in T-notes.
The face value of a single T-bond, or 30-year bond, futures contract is $100,000. Knowing this, it is easy to see why the exchange opted to quote the contract in terms of 1,000 points, or trading handles, worth $1,000 a piece. What is unlikely to be obvious is that each full point or handle can then be looked at as a fraction.
If you are unfamiliar with the term handle, it is often used to describe the stem of a quote. For instance, if the T-bond drops from 124’00 to 123’00, it is said to have moved a full handle. This move, by the way, represents a profit or loss of $1,000 to a futures trader.
Treasury bond futures trade in ticks equivalent to 1/32nds of a full point, or handle, valued at $31.25 figured by dividing $1,000 by 32. Adding to the confusion, in early 2008 the Chicago Board of Trade (Cbot) decided to alter the contract by allowing traders to buy or sell bond futures in half ticks or $15.625. A minimum price movement in the T-bond futures is now 0.5/32. On a quote board you may see something that looks like 117’245. Don’t mistake this for 117’245/32; it is actually 117’24.5/32. Read simply as “one-seventeen-twenty-four-and-a-half.”
Bonds are quoted in terms of their $1,000 handles; thus, a typical bond quote may be 124’21. This is read as 124 handles and 21/32nds and is equivalent to a contract value of $124,656.25. This is calculated by multiplying 124 by $1,000 and 21 by the point value of $31.25. You could also come to the same conclusion by multiplying the fraction, 24/32, by $1,000. In my opinion, this method causes the least confusion.
Those traders comfortable with the process of adding and subtracting fractions will easily be able to derive profit, loss and risk; those who are “fractionally” challenged may find trading Treasuries frustrating. The multiplication involved in bond and note futures calculations is relatively standard, but people tend to be intimidated by fractions. If you recall the concept of borrowing, you will be fine. I am confident that everyone will quickly become more comfortable with bond futures calculations after going over a few examples.
In some instances, the math is seamless. For example, a trader who buys a June bond futures contract at 123’10 and sells it at 124’20 could easily determine that the trade was profitable by 1-10/32nds or $1,312.50 ((1-10/32) x $1,000).
However, there will be times during which you will need to borrow from the handle to bring the fraction to a point in which you can figure the profit or loss; this is where many opt to trade another market. A trader who sells a June bond at 120’12 and buys the contract back at 118’27 may have a challenge when it comes to calculating her exact profit. In this case, it is easy to see that the trade was profitable because the trader bought low and sold high. However, unless you have been doing this for a while, it may take a little work to derive the net profit.
The numerator of the sell price, 12, is much smaller than the numerator of the buy price, 27. Therefore, we know that we must borrow from the handle to properly net the fractions; otherwise, we would end up with a negative number and unnecessary confusion. In this case, we must reduce the selling price handle to 119 from 120 and increase the fraction by 32/32nds. After reducing the selling price by a handle, we will add 32/32nds to the existing fraction of 12/32nds to arrive at 44/32nds.
Once this is done, it is possible to easily subtract 27/32 from 44/32nds to determine a profit of 1’17 ((119 - 118) + (44/32 - 27/32)). From here we can convert the fraction to dollar value by multiplying by $1,000. Assuming these fills, this trade would have been profitable by $1,531.25 before commissions and fees ((1-17/32) x $1,000).
As if trading bond futures weren’t difficult enough, the Cbot created options written on Treasury futures with a twist. Instead of quoting bond options in 32nds the way the futures contracts are, the exchange opted to value them in 64ths. The multiplier will remain $1,000 so each handle still carries the same value, with the only difference in figuring the options as opposed to the futures being the fraction by which it is multiplied. Therefore, if a trader purchases a June bond 135 call option for 20, he is actually paying 20/64ths or $312.50 ((20/64) x $1,000). Similarly, if that trader were later able to offset the option for 58, he would have locked in a profit of 38/64ths or $593.75 ((58/64) - (20/64) x $1,000) before consideration of commission and fees.