Reversed from options, What is a contract adjustment?


Limited Profit Potential

Updated Jul 8, What is a Reverse Conversion? A reverse conversion is a form of reversed from options that options strategies for an hour options traders to profit from an overpriced put option no matter what the underlying does.

reversed from options

The trade consists of selling a put and buying a call to create a synthetic long position while shorting the underlying stock. This means the trade short stock and synthetically long the stock with options is hedged, with the profit coming only from the mispricing of the option premiums. Key Takeaways A reverse conversion is an arbitrage situation in the options market where a put is overpriced or a call underpriced relative to the putresulting in a profit to the trader no matter what the underlying does.

The reverse conversion is created by shorting the underlying, buying a call, and selling a put.

Limited Risk

The call and put have the same strike price and expiry. A put option is typically cheaper, not more expensive, than the equivalant call option.

reversed from options

Therefore, finding a reverse conversion trade is rare. Understanding Reverse Conversion A reverse conversion is a form of arbitrage that enables traders to capitalize on situations where the put is overpriced by selling a put, buying a call, and shorting the underlying stock.

reversed from options

The call covers the short stock if it rises above the strike price and the put is covered by the shorted stock if the stock price is less than the strike price. The profit when initiating these positions is the theoretical arbitrage gain from the position that comes from the overpriced put option.

Example of a Reverse Conversion In a reversed from options reverse conversion transaction or strategy, a trader short sells stock and hedges this position by buying its call and selling its put.

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Whether the trader makes money depends on the borrowing cost of the shorted stock and the put and call premiums. Assume it is June and a trader sees an overpriced October put in Apple Inc.

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This is a rare situation since puts typically cost less than equivalent calls. Here's how the scenarios could play out.

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The call expires worthless, the short stock is assigned because the put buyer is in the money. This is why this is an arbitrage trade. Borrowing costs and commissions have been excluded in the example above for simplicity but are an important factor in the real world.

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The cost to exit will depend on whether the options are exercised or if the positions are exited prior to expiration. In either case, there will be additional costs to exit the trade, plus the borrowing costs on the shorted stock. Compare Accounts.