Strict Standards: Only variables should be assigned by reference in /home/futuresf/public_html/templates/futurefacts/index.php on line 168
Wednesday
,
Strict Standards: Only variables should be assigned by reference in /home/futuresf/public_html/templates/futurefacts/index.php on line 169
January

Strict Standards: Only variables should be assigned by reference in /home/futuresf/public_html/templates/futurefacts/index.php on line 170
17
,
Strict Standards: Only variables should be assigned by reference in /home/futuresf/public_html/templates/futurefacts/index.php on line 171
2018
Text size

Box Or Conversion/Reversal

box or conversion/reversal

conversion

a conversion is an arbitrage strategy in options trading that can be performed for a riskless profit when options are overpriced relative to the underlying stock. to do a conversion, the trader buys the underlying stock and offset it with an equivalent synthetic short stock (long put + short call) position.

conversion construction
long 100 shares
buy 1 at the money put
sell 1 at the money call

limited risk-free profit

profit is locked in immediately when the conversion is done and it can be computed using the following formula:

profit = strike price of call/put - purchase price of underlying + call premium - put premium

conversion

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 profit.

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 profit 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 as well as options on futures.

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.

however, for active traders, commissions can eat up a sizable portion of their profits 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 as they offer a low fee of only $0.15 per contract (+$8.95 per trade).

reversal

a reversal, or reverse conversion, is an arbitrage strategy in options trading that can be performed for a riskless profit when options are underpriced relative to the  underlying stock. to do a reversal, the trader short sell the underlying stock and offset it with an equivalent  synthetic long stock (long call + short put) position.

reversal construction
short 100 shares
sell 1 at the money put
buy 1 at the money call

limited risk-free profit

profit is locked in immediately when the reversal is done and it can be calculated using the following formula:

profit = sale price of underlying - strike price of call/put + put premium - call premium

reversal

example

suppose xyz stock is trading at $100 in june and the jul 100 call is priced at $3 while the jul 100 put is priced at $4. an arbitrage trader does a reversal by short selling 100 shares of xyz for $10000 while simultaneously buying a jul 100 call for $300 and selling a jul 100 put for $400. an initial credit of $10100 is received when entering the trade.

if xyz stock rallies to $110 in july, the short jul 100 put will expire worthless while the long jul 100 call expires in the money and is exercised to cover the short stock position for $10000. since the initial credit received was $10100, the trader ends up with a net profit of $100.

if instead xyz stock had dropped to $90 in july, the long jul 100 call will expire worthless while the short jul 100 put expires in the money and is assigned. the trader then buys back the obligated quantity of stock for $10000 to cover his short stock position, again netting a profit of $100.

note: while we have covered the use of this strategy with reference to stock options, the reversal is equally applicable using etf options, index options as well as options on futures.

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.

however, for active traders, commissions can eat up a sizable portion of their profits 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 as they offer a low fee of only $0.15 per contract (+$8.95 per trade).

Login to the Contributor Network