On This Page
- What are conversion and reversal arbitrage trades?
- How is conversion and reversal profit calculated?
- Worked example
- When to trade a conversion vs a reversal
- Dividends and early assignment in conversions and reversals
- Conversions and reversals in options flow
- Risks and limitations of conversions and reversals
- Bottom line
- FAQ
Key Takeaways
- A conversion is long the underlying combined with a long put and a short call at the same strike and expiration, so the package is worth exactly the strike at expiration regardless of where the stock settles.
- A reversal, which exchanges and margin rules call a reverse conversion, is the exact mirror: short the underlying, short the put, and long the call at one shared strike and expiration.
- Because the terminal value is fixed, the profit is not directional. It is the put-call parity mispricing measured net of financing, dividends, stock borrow, fees, and the bid-ask spread on three legs.
- With American-style options, the Cboe Margin Manual sets the underlying-leg maintenance component at 10% of strike, plus the short put’s in-the-money amount for a reversal. Broker requirements can be higher.
- Cboe Options automatically tags conversions and reversals in the StrategyID field because they qualify for fee caps, which reflects how routinely professional desks trade them.
- American-style early assignment, most often on the short call before an ex-dividend date, is the main way a supposedly locked conversion comes apart before expiration.
What are conversion and reversal arbitrage trades?
Conversion and reversal arbitrage trades are paired put-call parity positions that lock a stock-and-options package to a fixed strike value at expiration. A conversion combines long stock, long put, and short call at the same strike and expiration. A reversal takes the opposite legs: short stock, short put, and long call. The profit is the parity mispricing net of carry, not a directional move.
The conversion’s options form synthetic short stock, offsetting the long shares. The reversal’s options form synthetic long stock, offsetting the short shares. These complete packages turn directional exposure into a financing calculation. Match option quantities and deliverables to the shares.
How is conversion and reversal profit calculated?
For one unit of underlying, the conversion’s final value is S + max(K − S, 0) − max(S − K, 0) = K. The reversal’s corresponding liability is K. The entry prices and intervening cash flows determine profit.
At the strike, both options have zero intrinsic value. A conversion still holds stock worth K if neither option is exercised. The fixed value is an economic identity; actual delivery follows the contracts and exercise instructions.
A conversion costs S + P − C. Compare that outlay with the strike received and dividend cash flows, then subtract financing and execution costs. For a reversal, calculate the initial proceeds, final strike obligation, stock-loan charges, dividend payments, and interest actually credited to the account.
Formula
Conversion profit per share = K + D − (S + P − C) − carry; Reversal profit per share = (S + P − C) − K − D + rebate- S is the price paid or received on the underlying, C is the call premium, P is the put premium, and K is the strike shared by the call and the put.
- D is the cash dividend paid before expiration. A conversion receives it as the share owner; a reversal owes it to the stock lender.
- Carry is the interest cost of financing the net outlay (S + P − C) through expiration. Rebate is the interest earned on short-sale proceeds after the borrow fee.
- Results are per share. Multiply by the 100-share contract multiplier for dollars per package of one call, one put, and 100 shares.
Worked Example
Use 100 shares at $100, a three-month 100-strike call quoted $3.30 bid / $3.35 ask, and a matching put quoted $2.50 bid / $2.55 ask. The conversion stays intact through expiration, receives a $0.50 dividend per share, and finances its initial net outlay at 4% simple annual interest for 0.25 years. The dividend is held as cash after payment.
- Buy shares and the put; sell the call. Net outlay = $100 + $2.55 − $3.30 = $99.25 per share, or $9,925.
- Final stock-plus-option value = $100 per share. Gross gain before dividend and funding = $75.
- Financing = $9,925 × 4% × 0.25 = $99.25. Dividend received = $50.
- Modeled result = $10,000 + $50 − $9,925 − $99.25 = $25.75 before commissions and exchange fees.
- For the inverse package, sell stock and the put, then buy the call. Initial proceeds are $9,915. Crediting that entire net balance at an explicit 4% simple rate produces $99.15 interest. After the $10,000 final obligation and $50 dividend payment, the result is −$35.85.
The conversion and reversal hold opposite sides of the same exposure. Use the actual funding, stock-loan cash flows, dividends, and executed package price to calculate the net result. The quoted option spreads create different entry prices in the two directions.
Payoff at expiration
Illustrative figures from this page's example, priced by the InsiderFinance options profit calculator. Probability assumes 25% volatility, a 4% rate and 91 days to expiration.
- Max Profit
- $75.00
- Minimum Profit
- $75.00
Interactive payoff loads as you reach it
Load this setup on live SPY options. Move the strikes and scrub to any date.
Build This StrategyWhen to trade a conversion vs a reversal
When synthetic long exposure is rich relative to stock after carry, sell the synthetic and buy the shares: a conversion. When it is cheap, buy the synthetic and sell the shares: a reversal.
The example’s conversion costs $9,925 for 100 shares and matching options. Its $10,000 final value plus $50 dividend, less $99.25 financing, produces $25.75 before transaction charges. At the opposite bid and ask prices, the reversal receives $9,915. The stated net-balance interest convention produces a $35.85 loss. Carry the exact cash-flow convention through the calculation.
The options profit calculator shows the flat expiration payoff; add entry cash, financing, dividends, fees, and the broker’s buying-power requirement for the complete position, including payment for the long option, for the full economic result.
Dividends and early assignment in conversions and reversals
A conversion receives the dividend when it retains the shares through the entitlement date. Early assignment of its short call delivers those shares away. That assigned writer loses the expected dividend; an unassigned writer who keeps the shares retains the dividend entitlement.
Value the call’s exercise choice using the dividend, remaining option value, and financing. If the call is assigned, the conversion becomes a remaining long put after the shares leave. In a reversal, assignment of the short put buys shares that cover the stock short and leaves the long call.
Map those resulting positions before choosing the package. Keep the stock-loan and dividend cash flows in the same calculation as the option prices.
Conversions and reversals in options flow
Confirm the signs, quantities, common strike, expiration, and stock hedge before classifying a linked trade. A matched conversion or reversal is a hedged financing package. Stock, a call and a put printed together form that package only when every one of those checks lines up.
Cboe’s 2021 notice identifies the matching three-leg structures for its strategy tagging and fee-cap process. The package definition is useful for understanding prints; fee treatment alone does not establish who can trade the strategy.
Risks and limitations of conversions and reversals
- Check the short call before every ex-dividend date. Early assignment can break the lock: a conversion’s short call can be assigned before an ex-dividend date, which strips the dividend the trade counted on, and a reversal’s deep in-the-money short put can be assigned early.
- Price all three legs at executable quotes. Put-call parity says the residual should be near zero, so three bid-ask spreads, fees, and financing can erase the edge: at the opposite quotes, the example’s reversal loses $35.85.
- Confirm the borrow and its fee before a reversal. A recalled loan or a rising borrow fee can turn a positive carry calculation negative.
- Match quantities, strikes, expirations, and deliverables. The fixed value holds only for a matched package, and if the stock settles at the strike and neither option is exercised, the conversion still holds the shares after expiration.
Bottom line
Conversions and reversals turn put-call parity into a package whose expiration value is fixed at the strike, so the result is a financing calculation rather than a directional bet. Price every leg at executable quotes, include dividends, carry, borrow, and fees, and plan for early assignment before treating the package as locked.
Clear answers
Frequently Asked Questions
Sources and Further Reading
- OIC: Put/Call Parity Arbitrage Trades
- Cboe Margin Manual (November 30, 2021): Conversion and Reverse Conversion
- Cboe Options: Automatically Identify Reversal, Conversion, and Jelly Roll Strategies via StrategyID Field
- SEC OCIE Risk Alert: Illegal Options Trading Used to Reset Reg SHO Close-out Obligations
How entries are sourced, calculated and updated: editorial methodology.