What is a conversion in options trading?

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.

What is a reverse conversion trade?

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

What is a conversion & how does it work?

What Is a Conversion? A conversion is the exchange of a convertible type of asset into another type of asset—usually at a predetermined price—on or before a predetermined date. The conversion feature is a financial derivative instrument that is valued separately from the underlying security.

When should a trader use a conversion arbitrage strategy?

A trader will attempt to profit through a conversion arbitrage strategy when the call option is overpriced or the put is relatively underpriced. This can be due to market inefficiencies, or from the effects of mispriced interest rate assumptions.