Home MarketXLS
Dashboard MarketXLS
Screener MarketXLS
Stock Ranks MarketXLS
Spreadsheet Builder MarketXLS
Logout MarketXLS
Basics

Conversion Arbitrage Options Strategy

Written by Vanshika Kothari
Wed Jul 14 2021
Conversion Arbitrage
See how MarketXLS helps you take advantage in the markets.
Download Option Templates →
Conversion Arbitrage
 

Conversion arbitrage is an options trading strategy to take advantage of perceived inefficiencies present in the pricing of options. Also known as reversal-conversion (or reverse conversion), it is a strategy where the trader buys a put and writes a covered call (a call on a stock that they already own) with identical strike prices and expiration dates. It is considered a risk-neutral strategy where the trader profits when the call option is overpriced, or the put is underpriced due to market inefficiencies, or from mis-priced interest rate assumptions. 

How to Implement Conversion Arbitrage?

Conversion Arbitrage is best implemented when you believe that the options are overpriced relative to the underlying stock. It is an options arbitrage strategy that takes advantage of discrepancies in the value of synthetic positions, and they’re represented equally to return a risk-free profit. However, the profit that can be earned using this strategy is limited.

In this strategy, traders go long on the underlying stock, and the ATM put option contract, and short on the ATM call option contract. Both the options are of the same underlying security and have the same expiration date.

To implement conversion arbitrage options strategy, they buy the underlying stock and simultaneously offset that trade with an equivalent synthetic short stock position (long put + short call). As a result, the long stock position carries a positive 100 delta, while the synthetic short stock position using options has a negative 100 delta, making the strategy delta neutral or insensitive to the market’s direction.

Example (Using MarketXLS Template)

Conversion Arbitrage

MarketXLS provides a template for this strategy. The yellow cells have to be inputted by the user. Here, Provide the Stock Ticker, Expiry Date, ATM strike price for Call/Put, and the Buy Price and Quantity of the long stock. Upcoming expiry dates are available for reference. 

We have used Microsoft (Nasdaq: MSFT), Expiry date as 28 May 2021, ATM strike price is 245 and the Buy Price and Quantity of the long stock is 245 and 100. So voila, we have built the Conversion Arbitrage Strategy for MSFT

We have entered into a long stock position of MSFT with the buy price and quantity 245 and 100. And on the options front, we have bought 1 ATM $245 put option contract and sold 1 ATM $245 call option of MSFT. As a result, we have built the net credit strategy and received 124 dollars outright to enter into the trade, reflected in the net cash flow section.

SNXyOvcgT8Z7IsRSUK-74QqoIu” alt=”Conversion Arbitrage”/>

Find this template here: https://marketxls.com/template/conversion-reverse-arbitrage-strategy/

A payoff schedule and payoff diagram are available in the template too. They can be used to analyze the maximum gain, loss, and break-even.  

Maximum gain is limited and is locked in immediately when the conversion arbitrage is done, as shown by the blue box. It can also be computed using a formula:

Profit = Strike Price of Call/Put – Purchase Price of Underlying + Call Premium – Put Premium.

Being a risk-free strategy, it is insensitive to the market’s direction, so there are no chances of a loss. However, the difference between the synthetic position and its actual instrument is usually so small that it hardly justifies the commissions paid on the position.

The Bottom Line

Arbitrage opportunities enable investors to earn risk-free profits, and hence these opportunities are absorbed by the market and fade away very quickly.  Additionally, transaction costs such as broker fees and margin interest for executing options and short-selling stock involving apparent arbitrage opportunities may not exist in practicality.

Disclaimer

All trademarks referenced are the property of their respective owners. Other trademarks and trade names may be used in this document to refer to either the entity claiming the marks and names or their products. MarketXLS disclaims any proprietary interest in trademarks and trade names other than its own, or affiliation with the trademark owners.
None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein. The article is written for helping users collect the required information from various sources deemed to be an authority in their content. The trademarks if any are the property of their owners and no representations are made.

Interested in building, analyzing and managing Portfolios in Excel?
Download our Free Portfolio Template
Download Option Templates
Stock screens
Public saved screens

Top 100 Gainers Today

Top 100 losers Today

Call: 1-877-778-8358
Ankur Mohan MarketXLS
I am so happy you are here. My name is Ankur and I am the founder/CEO of MarketXLS. Over the past four years, I have helped more than 2500 customers to implement their own investment research strategies and monitoring systems in Excel.
Get Access to 1 Billion Usable Market data points IN YOUR EXCEL SHEETS WITH EASY TO USE EXCEL FUNCTIONSGet started today
Search for a stock

Get Access to 1 Billion Usable Market data points IN YOUR EXCEL SHEETS WITH EASY TO USE EXCEL FUNCTIONS

Get started today

Top MarketXLS Rank stocks

STORE Capital Corporation logo

STORE Capital Corporation

31.58
 
USD
 
-0.14
 
(-0.44%)
77
Rank
Optionable: Yes
Market Cap: 8,978 M
Industry: REIT - Diversified
52 week range    
24.48   
   36.13
Dillard's Inc. logo

Dillard's Inc.

280.00
 
USD
 
-6.76
 
(-2.36%)
77
Rank
Optionable: Yes
Market Cap: 5,077 M
Industry: Department Stores
52 week range    
167.03   
   416.71
Williams-Sonoma Inc. (DE) logo

Williams-Sonoma Inc. (DE)

125.49
 
USD
 
-3.52
 
(-2.73%)
76
Rank
Optionable: Yes
Market Cap: 8,796 M
Industry: Specialty Retail
52 week range    
101.58   
   223.32
ICF International Inc. logo

ICF International Inc.

108.01
 
USD
 
-0.46
 
(-0.42%)
74
Rank
Optionable: Yes
Market Cap: 2,040 M
Industry: Business Services
52 week range    
84.68   
   111.10
First Interstate BancSystem Inc. logo

First Interstate BancSystem Inc.

41.49
 
USD
 
-1.14
 
(-2.67%)
74
Rank
Optionable: Yes
Market Cap: 4,622 M
Industry: Banks - Regional - US
52 week range    
32.40   
   45.33
Global Cord Blood Corporation logo

Global Cord Blood Corporation

2.99
 
USD
 
0.77
 
(34.58%)
74
Rank
Optionable: Yes
Market Cap: 317 M
Industry: Biotechnology
52 week range    
2.03   
   5.50
Penske Automotive Group Inc. logo

Penske Automotive Group Inc.

100.37
 
USD
 
-3.16
 
(-3.05%)
73
Rank
Optionable: Yes
Market Cap: 7,684 M
Industry: Auto & Truck Dealerships
52 week range    
88.58   
   126.93
General Mills Inc. logo

General Mills Inc.

79.17
 
USD
 
-1.61
 
(-1.99%)
72
Rank
Optionable: Yes
Market Cap: 44,923 M
Industry: Packaged Foods
52 week range    
58.85   
   81.24
Allegiance Bancshares Inc. logo

Allegiance Bancshares Inc.

43.90
 
USD
 
0.18
 
(0.41%)
72
Rank
Optionable: Yes
Market Cap: 883 M
Industry: Banks - Regional - US
52 week range    
35.99   
   46.96
National Research Corporation logo

National Research Corporation

39.24
 
USD
 
0.49
 
(1.26%)
71
Rank
Optionable: No
Market Cap: 948 M
Industry: Diagnostics & Research
52 week range    
30.93   
   52.36

More Features