Reversal

Conversion: Long stock + Long put + Short call (profits when CALLS overpriced). Reversal: Short stock + Short put + Long call (profits when PUTS overpriced). They're mirror images exploiting opposite put-call parity violations.

Reversals require shorting stock, which adds: (1) Borrow requirement - must find shares to borrow, (2) Borrow cost - ongoing fee to borrow shares, (3) Dividend obligation - you owe any dividends paid, (4) Recall risk - lender can demand shares back. Conversions simply buy stock.

You OWE dividends. As a short seller, you must pay any dividends to the share lender. This is a cost that reduces your profit. Always check the dividend calendar before entering a reversal.

No. Reversals require short stock and a short put, both of which need margin. TFSAs don't allow margin or short selling. You need a margin account with Level 4 options approval.

Due to put skew - puts typically carry a 'fear premium' making them more expensive than theoretical parity suggests. This happens because investors buy puts for protection, driving up demand and prices.

Borrow cost = Stock Price × Annual Rate × (DTE/365). Example: $80 stock × 2% × (60/365) = $0.26 per share = $26 per 100 shares. Subtract this from your gross edge to get net edge.

If assigned, you buy 100 shares at the strike. This effectively covers your short stock position. You still have the long call (which may be worthless if stock is below strike). The reversal is essentially closed - calculate your final P&L.

Put skew spikes during: (1) Market stress/crashes, (2) Before uncertain earnings, (3) Before binary events (FDA decisions, lawsuits), (4) During high hedging demand. When puts are very expensive due to fear, reversal opportunities may exist.

Synthetic short (long put + short call) has unlimited risk if stock rises. Reversal (add short stock) creates a flat position - no directional risk. If you want to capture put overpricing without directional exposure, reversal is theoretically risk-free. But the borrow cost of the reversal is the price of this safety.

When you short stock, you borrow shares from a lender. The lender can demand those shares back ('recall') at any time. If recalled, you must cover immediately, potentially disrupting your reversal. Institutional traders use 'term borrows' to lock in shares for a specific period.

A reversal is like borrowing money: You receive proceeds today (short stock + put - call) and pay a fixed amount (strike) at expiration. The implied rate = ln((S - P + C) / K) / T. If this rate is lower than your alternative borrowing cost, the reversal is attractive as a financing tool.

If borrow costs are high or rising, and the options market offers a cheaper synthetic equivalent, an institution might: (1) Cover the short stock, (2) Enter synthetic short (long put + short call). This is borrow cost arbitrage. Alternatively, they might enter a full reversal if puts are rich enough.

Put skew typically spikes before earnings (puts get expensive - potentially creating opportunity), then collapses after (IV crush). If you entered for skew normalization, the earnings event is the catalyst. Risk: If stock crashes, even though you're theoretically flat, early assignment could create complexity. Generally, avoid holding arbitrage positions through binary events unless that's your thesis.

A box spread = Conversion at one strike + Reversal at another strike. Or: Bull call spread + Bear put spread. All three are interest rate arbitrage strategies. Box spread compounds the rate relationship across two strikes. If you understand conversions and reversals, you understand the building blocks of boxes.

Edges might persist when: (1) Borrow is genuinely difficult or expensive, (2) Dividend risk is high, (3) Extreme put skew during crisis (arbitrageurs may not have capital), (4) Illiquid options with wide spreads. True arbitrage edges are quickly eliminated, but risk-adjusted edges may persist because the 'arbitrage' carries risks most can't manage.