Reverse Conversion

DEFINITION of 'Reverse Conversion'

A finance and risk management technique based on a put-call parity strategy that consists of selling a put and buying call (a synthetic long position), while shorting the underlying stock. As long as the put and call have the same underlying, strike price and expiration date, a synthetic long position will have the same risk/return profile as ownership of an equivalent amount of the underlying stock.

BREAKING DOWN 'Reverse Conversion'

In a typical reverse-conversion transaction, a brokerage firm short sells stock and hedges this position by buying its call and selling its put. Whether the brokerage firm makes money depends on the borrowing cost of the shorted stock and the put and call premiums, all of which may render a return better than the money market with very low risk. In the context of futures markets, a trader would be synthetically long and short the underlying futures while looking for arbitrage opportunities.

RELATED TERMS
  1. Synthetic Call

    An investment strategy that mimics the payoff of a call option. ...
  2. Synthetic Forward Contract

    A position in which the investor is long a call option and short ...
  3. Long Jelly Roll

    An option strategy that aims to profit from a time value spread ...
  4. Covered Combination

    An option strategy that involves the simultaneous sale of an ...
  5. Broad Index Synthetic Trust Offering ...

    Proprietary name used by J.P. Morgan for creating collateralized ...
  6. Long Straddle

    A strategy of trading options whereby the trader will purchase ...
Related Articles
  1. Trading

    Put-Call Parity And Arbitrage Opportunity

    Look at trades that are profitable when the value of corresponding puts and calls diverge.
  2. Markets

    Get Into Low-Cost Futures Trading With Synthetics

    If you can't trade commodity futures outright, these vehicles provide a less expensive alternative.
  3. Markets

    What is Put-Call Parity?

    Put-call parity describes the relationship that must exist between European put and call options with the same expiration date and strike prices.
  4. Trading

    Trading Volatility? Don’t Trade Stocks, Trade Options

    During times of volatility, traders can benefit greatly from trading options rather than stocks. We explain why.
  5. Trading

    Risk Reversals for Stocks Using Calls and Puts

    Risk reversal strategies can be a very useful “option” for experienced investors who are familiar with basic puts and calls.
  6. Investing

    Conversion Arbitrage: How Does It Work?

    By John SummaIn the previous section of this tutorial, we saw that conversions and reversals are three-legged strategies combining stock and options positions. Still remaining with the simplified ...
  7. Markets

    Interest Rate Arbitrage Strategy: How It Works

    Changes in interest rates can give rise to arbitrage opportunities that, while short-lived, can be very lucrative for traders who capitalize on them.
  8. Managing Wealth

    Strategies for Trading Volatility With Options (NFLX)

    These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility.
  9. Trading

    Solving Mixed Options Problems On The Series 7

    Learn to ace the questions that involve both options contracts and stock positions.
  10. Trading

    How To Protect A Short Position With Options (FB, AAPL)

    Short selling can be a risky endeavor, but the inherent risk of a short position can be mitigated significantly through the use of options.
RELATED FAQS
  1. What's the difference between a long and short position in the market?

    Understand long and short positions for stocks and option contracts; combine long and short positions for added leverage ... Read Answer >>
  2. How do I determine what the right situation is to make a covered call?

    Learn what a covered call is, how to use a covered call strategy, and what situations to sell a call option against a long ... Read Answer >>
  3. What techniques are most useful for hedging exposure to the telecommunications sector?

    Learn about option strategies used to hedge a long stock position in the telecommunications sector, including bear put spreads ... Read Answer >>
  4. How is a short call used in a collar option strategy?

    Learn how a short call is used in a collar option strategy, and see how this strategy has a limited risk and a limited return ... Read Answer >>
  5. How can I use equity options to protect my stock portfolio from downturns?

    Learn about stock options, how to use them to hedge stock positions and how they could help to protect stock portfolios from ... Read Answer >>
  6. How is the Put-Call Ratio calculated and where does the information come from?

    Discover how major exchanges and financial websites, such as the Chicago Board of Exchange, compile data for their respective ... Read Answer >>
Hot Definitions
  1. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  2. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  3. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  4. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  5. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  6. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
Trading Center