Conversions are chiefly a Floor Trader strategy used to capitalize on minor price discrepancies between calls and puts. Involving the buying of something in one market and simultaneously selling it in another. This is normally done when options are relatively overpriced. To put on the position, the trader buys stock on the open market and sells the equivalent position in the option market. Conversions have very little risk involved because the profit is locked in immediately.
The idea is to create a synthetic short position and offset it with a long position in the same underlying stock. A synthetic short position is created by selling a call and buying a put with the same strike price and expiration. Combining the synthetic short position with a long stock position creates the conversion. In the absence of any price discrepancies the Call Price minus the put Price equals the stock price minus the strike price.
Individual investors and other off-the-floor traders rarely have the opportunity to do conversions and reversals because price discrepancies normally only exist for a matter of moments. Professional option traders, however, are continually on the lookout for such opportunities. As a result, the market quickly balances itself out.
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