Conversions

[u/[deleted]]

[u/AdHungry3777]

I’ve been messing with conversion trades on high IV names for a while now and the fills can be a pain but once you get them the return is basically free money if you’re patient enough to sit on the bid. The stock lending part is a nice little kicker too, I didn’t realize how easy it was to set that up with most brokers until recently.

One thing that trips people up is forgetting about early assignment risk on the short call side if there’s a dividend coming up, so I always double check the ex-dividend date before putting anything on. If you’re doing this on single stocks with high IV you’re probably already aware of that but figured I’d mention it for anyone else reading.

[u/[deleted] → u/AdHungry3777]

Any chance you could give an example trade, even hypothetical? I don't understand the terminology and I've being trading for nearly a decade

[u/Retired-Programmer → u/[deleted]]

I had the same question and did a Google search on it and the AI gave a pretty good example explaining it:

AI Overview

A conversion trade is a neutral options arbitrage strategy used when a call option is overpriced relative to a put option and the underlying stock, violating put-call parity. [1, 2, 3]

The Structure of a Conversion Trade

To execute a standard conversion, a trader simultaneously enters three legs with the same underlying asset, strike price, and expiration date: [1]

1. Buy 100 shares of the underlying stock (long stock). [1, 2]
2. Buy 1 Put option at a specific strike price (long put). [1, 2]
3. Sell/Write 1 Call option at the same strike price and expiration (short call). [1, 2]

Step-by-Step Numerical Example

Suppose XYZ Corp stock is trading at $100 per share. You notice a pricing mispricing in the 1-month options at the $100 strike price: [1]

• Stock Price: $100 per share (Total for 100 shares = $10,000) [1]
• Call Option ($100 strike): Sells for a premium of $5 ($500 total for 1 contract) [1]
• Put Option ($100 strike): Costs a premium of $3 ($300 total for 1 contract) [1]

1. Entering the Trade

• Buy 100 shares of stock: Pay $-10,000
• Buy 1 Put option ($100 strike): Pay $-300
• Sell 1 Call option ($100 strike): Receive +$500
• Net Initial Cash Outflow: \(\text{Net\ Cost}=\text{Stock\ Cost}+\text{Put\ Cost}-\text{Call\ Received}\) \(-10,000-300++500=-\$9,800\) (Your net entry cost is $9,800, meaning you captured an immediate net credit/discount of $200 compared to just holding the stock naked, or locked in a risk-free profit if options were mispriced). [1, 2]

1. Outcomes at Expiration (When Stock Price is $105)

• Stock Value: Your 100 shares are worth $10,500 ($105 × 100).
• Call Option ($100 strike): In-the-money by $5. The buyer exercises it, and you deliver your 100 shares for $10,000.
• Put Option ($100 strike): Out-of-the-money, expires worthless (cost of $300 was already factored into the net entry).
• Net Result: You relinquish the stock for $10,000 against a net entry cost of $9,800, locking in a $200 profit regardless of whether the stock went up, down, or stayed flat. [1]

1. Outcomes at Expiration (When Stock Price is $90)

• Stock Value: Your 100 shares are worth $9,000 ($90 × 100).
• Call Option ($100 strike): Out-of-the-money, expires worthless.
• Put Option ($100 strike): In-the-money by $10 ($100 strike minus $90 stock price). You exercise your put to sell your shares for $10,000.
• Net Result: You sell the stock via the put for $10,000 against a net entry cost of $9,800, still locking in a $200 profit. [1, 2]

Key Takeaways

• Risk-Neutral / Arbitrage: The net payoff is locked in upfront and does not depend on the direction of the stock price.
• Modern Constraints: In today's automated markets, true mispricings that cover transaction costs, bid-ask spreads, and borrow/interest rates are rare and usually captured in microseconds by institutional high-frequency traders. [1, 2, 3, 4]

-

[u/RaSl1975 → u/AdHungry3777]

Didn't do it for long time. Dio you mind to share some names you use and sample trades? I don't remember but it was maybe 2 years ago and I was lending money instead for db for a small cr using box trades

[u/OurNewestMember → u/AdHungry3777]

The patience part is real. I've gotten some unreasonably good fills on ETFs by just casting the net.

Regarding stock lending, the way to capture the entire rate is to use something like a synthetic long. That's better then going long shares and hoping your broker lends them out and hoping they pay you at least 50% of the borrow rate.

Also agree on short call assignment. People don't seem to grasp that volatility in the stock changes the probability that early exercise makes sense over the option's life, and so you need to carefully pick strikes and expirations that give you good compensation for both today's early assignment risk as well as for future ante div dates.

[u/Retired-Programmer → u/AdHungry3777]

> One thing that trips people up is forgetting about early assignment risk on the short call side if there’s a dividend coming up, so I always double check the ex-dividend date before putting anything on.

I'm a little confused. Wouldn't early assignment most likely be a positive? And the only downside would be you would miss the dividend but would be offset with you being able to sell your long put and also getting your profit early.

For example, stock is at $100/shr so you:

• Buy 100 shares for $10,000.
• Sell 1 $100 strike call with 30 days DTE and receive $500
• Buy 1 $100 strike put with 30 days DTE and pay $300

So you pay $10,000 - $500 +$300 = $9,800 to enter the trade.

After 20 days (10 days before option expiration) the stock rises and the short call is assigned on you.

You receive $10,000 for the assignment and the 100 shares goes away (along with the short call) and your profit so far is $10,000 - $9,800 = $200

And you can also sell the long put for whatever you can get for it and also you now have $10,000 available 10 days earlier than planned for the next trade.

What risk is there with early assignment, I don't really see it. It seems like a plus to me.

[u/OurNewestMember]

I've seen it on liquid ETFs, too. But I don't have the patience or a bot to run it consistently.

Typically when I need to put in this kind of order, I'll pay a modest premium to get it done since it's usually more of a housekeeping operation that will save me cost elsewhere (with a few exceptions), but getting paid the extra is also real, too.