Conversion Arbitrage

AAA

DEFINITION of 'Conversion Arbitrage'

An options trading strategy employed to exploit the inefficiencies that exist in the pricing of options. Conversion arbitrage is a risk-neutral strategy, whereby the trader buys a put and writes a covered call (on a stock that the trader already owns) with identical strike prices and expiration dates. A trader will profit through a conversion arbitrage strategy when the call option is overpriced.

INVESTOPEDIA EXPLAINS 'Conversion Arbitrage'

If the price of the underlying security falls, the put purchased increases in value by the same amount as the loss incurred by writing the call. If the underlying security's price increases, both the put and the call expire worthless. In both situations, the trader is risk neutral, but profits from the difference between the price at which the call was sold and the put was purchased.

As with all arbitrage opportunities, conversion arbitrage is rarely available. This is because any opportunity for risk-free money is acted on quickly by those who can spot these opportunities quickly.

RELATED TERMS
  1. Currency Arbitrage

    A forex strategy in which a currency trader takes advantage of ...
  2. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
  3. Arbitrage

    The simultaneous purchase and sale of an asset in order to profit ...
  4. Covered Call

    An options strategy whereby an investor holds a long position ...
  5. Put Option

    An option contract giving the owner the right, but not the obligation, ...
  6. Risk Neutral

    Indifference to risk. The risk-neutral investor would be in the ...
Related Articles
  1. Arbitrage Squeezes Profit From Market ...
    Options & Futures

    Arbitrage Squeezes Profit From Market ...

  2. Trading The Odds With Arbitrage
    Options & Futures

    Trading The Odds With Arbitrage

  3. Put-Call Parity And Arbitrage Opportunity
    Options & Futures

    Put-Call Parity And Arbitrage Opportunity

  4. An Introduction To Behavioral Finance
    Active Trading Fundamentals

    An Introduction To Behavioral Finance

comments powered by Disqus
Hot Definitions
  1. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate ...
  2. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  3. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  4. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  5. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  6. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
Trading Center