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What are Reversals and Conversions?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 30 March 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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As examples of two of the most basic components in the area of option arbitrage, reversals and conversions work hand in hand to allow the stockholder the chance to increase the profit of the stock portfolio. This is accomplished by systematically purchasing new shares of stocks (the conversion) and then selling older synthetic options (reversal) at a price that is slightly higher than the cost of purchasing the new options.

On thing to keep in mind is that the application of reversals and conversions does not rely on the difference in price between the new stock options and the older options that are being sold. While the stock prices are one factor in successfully using reversals and conversions to make money, they are not the only factors to consider. The price of the call must also be taken into consideration, as well as the put for both sets of stocks.

In order to ensure that an increase is made from the trading, it is important to consider every expense associated with both the purchase and the sale of the stock options. Looking at purchase prices alone would not necessarily lead to making a profit or increasing the value of the portfolio. But approaching the task with an eye open to stock price, call price and put charge will allow the investor to know if the strategy he or she has in mind will result in positive results. Without paying attention to these factors, the use of reversals and conversions are not likely to result in positive results.

Also, there is no rule that says stock options must be bought first and then other options sold. The process of reversals and conversions will work just as well if stock options are called and sold first, then other stocks are picked up. In either case, the key is to keep track of related expenses, and make sure there will be enough profit made to cover all costs. This means taking into consideration that each option would cover a group of shares in the stock, and even a few cents profit on each share could lead to a healthy increase in the value of the portfolio.

Employing reversals and conversions is all about trading up. By using a strategy that allows the stock holder to use existing resources to obtain stocks that are of more value, and do so while still covering all expenses related to the trading, it is possible to build a stock portfolio over time that will provide a great deal of financial security.

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