Explore Your Options by Tom Gentile
Iíve heard professional option traders use a spread called a ďconversionĒ to establish risk-free positions. Is this true? And if so, why donít we hear more about these strategies, or is this something the larger players donít want us to know about?
While there may be some situations out there that merit consideration, the establishment of conversions, or the other side of the trade, the reversal, arenít prime suspects. These spreads arenít risk-free positions, as much as they are nondirectional arbitrage strategies.
With a conversion or reversal, synthetic stock is built using same-month, same-strike calls and puts that are executed as a hedge against a stock position of the same ratio size. In the case of the conversion, the trader has bought a 1-to-1 ratio of long stock and synthetic short stock using a short call and long put. To establish the reversal, the position would maintain short stock, a short put, and long call.