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A conversion is an arbitrage strategy in options trading that can be performed for a riskless
prot when options are overpriced relative to the underlying stock (underlying-security.aspx).
To do a conversion, the trader buys the underlying stock and oset it with an equivalent
synthetic short stock (synthetic-short-stock.aspx) (long put + short call) position.
Conversion Construction
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Example
Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at $4 while the JUL
100 put is priced at $3. An arbitrage trader does a conversion by purchasing 100 shares of XYZ
for $10000 while simultaneously buying a JUL 100 put for $300 and selling a JUL 100 call for
$400. The total cost to enter the trade is $10000 + $300 - $400 = $9900.
Assuming XYZ stock rallies to $110 in July, the long JUL 100 put will expire worthless while the
short JUL 100 call expires in the money and is assigned. The trader then sells his long stock for
$10000 as required. Since his cost is only $9900, there is a $100 prot.
If instead XYZ stock had dropped to $90 in July, the short JUL 100 call will expire worthless while
the long JUL 100 put expires in the money. The trader then exercises the long put to sell his
long stock for $10000, again netting a prot of $100.
Note: While we have covered the use of this strategy with reference to stock options, the conversion is
equally applicable using ETF options, index options (index-options.aspx) as well as options on futures
(futures-option.aspx).
Commissions
For ease of understanding, the calculations depicted in the above examples did not take into
account commission charges as they are relatively small amounts (typically around $10 to $20)
and varies across option brokerages (choosing-an-options-brokerage.aspx).
However, for active traders, commissions can eat up a sizable portion of their prots in the long
run. If you trade options actively, it is wise to look for a low commissions broker. Traders who
trade large number of contracts in each trade should check out OptionsHouse.com
(http://www.anrdoezrs.net/hd108cy63y5LORNVRQNLNMVSTOTM) as they oer a low fee of
only $0.15 per contract (+$4.95 per trade).
Reverse Conversion (Reversal)
If the options are relatively underpriced, the reversal (reversal.aspx) is used instead to perform
the arbitrage trade.
Continue Reading...
Buying Straddles into Earnings (buying-straddles-into-
earnings.aspx)
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down
following the quarterly earnings report but often, the direction of the movement can be
unpredictable. For instance, a sell o can occur even though the earnings report is good if
investors had expected great results....[Read on...] (buying-straddles-into-earnings.aspx)
Options Arbitrage
Overview (options-arbitrage.aspx)
Conversion (conversion.aspx)
Reversal (reversal.aspx)
Synthetic Positions
Overview (synthetic-position.aspx)
Options Strategies
Buying Options (buying-options.aspx)
Outlook on Underlying:
Bullish
Prot Potential:
Loss Potential:
Credit/Debit:
No. Legs:
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Operations and their execution can be very risky and may result in signicant losses or even in a total loss of all funds
on your account. You should not risk more than you aord to lose. Before deciding to trade, you need to ensure that
you understand the risks involved taking into account your investment objectives and level of experience. Information
on this website is provided strictly for informational and educational purposes only and is not intended as a trading
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