Options Conversion Strategy

A Conversion is an arbitrage strategy in options trading that can be performed when options are overpriced relative to the underlying stock.  This strategy falls in the arbitrage category; thus, if it is executed well then you can get riskless profit.

In this post I will explain with example how this strategy can be carried out.  More examples of Conversion strategies are on this page.  To do a conversion, the trader buys the underlying stock and offset it with an equivalent synthetic short stock (long put + short call) position.  The underlying stock in this case will be under priced, or, will be at price less than the synthetic short.

The Underlying

On 22 Nov 2016, Marico was trading at 251.55.  Refer below screenshot for details.  Also note the price for the 260 call and put options.


Strategy Positions

To implement the strategy, 260 call option is sold for 1.2.  Put option is bought at 7.75 and the stock is bought at 251.55.  Picture below shows more details about the quantity which depends on lot size, Margin, and other details.


Strategy Performance

The graph below depicts how this strategy will fare for different closing price of the underlying on expiry.  You will notice that irrespective of the value of the underlying, at expiry the strategy gives a positive return.


Strategy Summary

The strategy provides a return of 1.12% on the Total Investment


Given that the investments are generally over shorter horizon, the annualized returns are greater.  In this case the 1 Month return is 17.22%.  This is further amplified in case the strategy is executed nearer to expiry.

Examples of Conversion and Reversion Strategies

In one of my previous blog, I had explained about Conversion Strategy.  At FinArbitrage, we do lot of analysis on a day-to-day basis to search for executable examples of Conversion Reversion Strategies.

As on 29 November 2016, below are the available instances of such strategies.

Points of Caution

  1. These strategies are arbitrage strategies, and as such gets snatched as soon as available.  There are many human as well as automated programs being run by specialized investment desk in search of these strategies.
  2. It is paramount that all the multiple legs of a particular strategy be executed in one go.  Only if all legs are available at an instance, the particular instance of these Conversion or Reversion needs to be entered into.  Thus no leg of the strategy can be entered into in isolation.
  3. Once a particular strategy is executed, it needs to be kept intact till expiry so as to realize the planned gain.  Thus available margin on an ongoing basis need to be monitored and any additional margin as required will have to be made available.