Reversal

Reversals profit when synthetic long is overpriced (P-C too high). Conversions profit when synthetic short is overpriced (C-P too high). Only one direction can be profitable at any time. Additionally, reversals don't require buying stock (capital intensive), but do require borrowing shares. For non-dividend stocks, reversal may be more capital efficient.

If shares aren't available to borrow, you simply cannot execute a reversal on that stock. This is a hard constraint. You could check other brokers for availability, wait for shares to become available, or look at conversion (which doesn't require borrowing) if that direction is mispriced.

Borrow rates vary dramatically. Easy-to-borrow stocks (large caps like BHP, CBA) might cost 0.25-1% annually. Moderate stocks might be 2-5%. Hard-to-borrow stocks (heavily shorted, small cap) can be 10-50%+ or simply unavailable. Always check the rate before assuming a reversal is profitable.

Yes, absolutely. When you short stock, you borrow it from someone who owns it. They're entitled to their dividend. You must pay them the dividend amount on the payment date. This is a contractual obligation of short selling, and it significantly affects reversal economics.

In theory, yes - when parity is violated and all costs are covered. In practice: execution risk (prices move while entering legs), borrow risk (shares recalled), and cost uncertainty (borrow rates can change) add complications. 'Risk-free' assumes perfect execution and stable borrow - real-world has friction.

Net Profit = Actual (P-C) - Theoretical (P-C) - Transaction Costs - Borrow Cost - Dividend Payment. Borrow cost = Stock price × Borrow rate × (Days/365). If you earn short rebate, it offsets borrow cost. Only proceed if Net Profit > 0.

You receive stock at the strike price, which covers your short position. Your call remains. The economic outcome is the same as holding to expiration - you effectively paid the strike to close your short. Early assignment actually saves you remaining borrow fees.

Reversal may be better when: 1) No dividends to pay (growth stocks), 2) You have cheap borrow access, 3) Stock purchase capital is constrained (margin for reversal may be less than stock cost for conversion), 4) Short rebate is attractive. For dividend-paying Australian stocks, conversions are usually superior.

Yes! Borrow rates can change daily based on supply/demand. If a stock becomes hard-to-borrow while you're holding a reversal, your costs increase. Rates are typically stable for easy-to-borrow stocks but can spike for popular shorts. Factor this risk into position sizing.

Recall risk is when the share lender demands their shares back. You must return them by buying in the market. While your options hedge some of this, forced timing can disrupt arbitrage. For easy-to-borrow stocks with many lenders, recall risk is low. For concentrated short stocks, it's higher.

Market makers use reversals to hedge long option inventory (especially puts). If a market maker accumulates long put exposure from customer flow, a reversal creates a full hedge with known profit/loss. They may do reversals at unfavorable prices if the hedge value exceeds the direct cost - this is why 'mispricings' can exist briefly.

Option prices adjust to reflect borrow costs. Puts become expensive relative to calls because arbitrageurs with cheap borrow are selling expensive puts and buying cheap calls. The 'mispricing' you see is correct pricing for the TRUE borrow cost. If you can't access cheap borrow, there's no arbitrage for you.

Reversals are essentially synthetic lending - you're lending the strike value at the implied rate. If reversal implied rate exceeds your funding cost, you profit from the rate differential. Institutions use reversals for cheap funding when rates are favorable relative to their alternatives.

Components: 1) Real-time options data feed, 2) Real-time borrow rate feed from broker API, 3) Dividend calendar, 4) Parity calculator including all costs, 5) Alert engine when mispricing > threshold, 6) Borrow availability pre-check. Challenge: By the time you alert and can execute, professionals have captured the opportunity.

Very dangerous! In squeeze conditions, borrow rates spike (costs explode), shares may be recalled (forced cover at bad prices), and option pricing can become erratic. The 'cheap' synthetic long reflects cheap options, but the expensive borrow makes reversal unprofitable. Avoid reversals on squeeze candidates.