Conversion Arbitrage

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.

BREAKING DOWN '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. Put Option

    An option contract giving the owner the right, but not the obligation, ...
  3. Covered Call

    An options strategy whereby an investor holds a long position ...
  4. Risk Neutral

    Indifference to risk. The risk-neutral investor would be in the ...
  5. Call Option

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

    The simultaneous purchase and sale of an asset in order to profit ...
Related Articles
  1. Options & Futures

    Arbitrage Squeezes Profit From Market Inefficiency

    This influential strategy capitalizes on the relationship between price and liquidity.
  2. Options & Futures

    Trading The Odds With Arbitrage

    Profiting from arbitrage is not only for market makers - retail traders can find opportunity in risk arbitrage.
  3. Options & Futures

    Put-Call Parity And Arbitrage Opportunity

    Look at trades that are profitable when the value of corresponding puts and calls diverge.
  4. Active Trading Fundamentals

    An Introduction To Behavioral Finance

    Curious about how emotions and biases affect the market? Find some useful insight here.
  5. Options & Futures

    Hedge Funds Hunt For Upside, Regardless Of The Market

    Hedge funds seek positive absolute returns, and engage in aggressive strategies to make this happen.
  6. Options & Futures

    Conversion Arbitrage

    This stock/options combination helps traders take advantage of market mispricing. Find out how.
  7. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  8. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  9. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  10. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
RELATED FAQS
  1. What is arbitrage?

    Arbitrage is basically buying in one market and simultaneously selling in another, profiting from a temporary difference. ... Read Full Answer >>
  2. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  3. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  4. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  5. Can mutual funds invest in options and futures? (RYMBX, GATEX)

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  6. Is there a difference between financial spread betting and arbitrage? (AAPL, NFLX)

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center