Conversion

In terms of market risk, yes - the position has zero delta and the outcome is predetermined. However, there are execution risks (failing to fill all legs), early assignment risk (short call may be assigned), and operational risks (errors). Also, transaction costs often exceed the arbitrage profit for retail traders, making it unprofitable rather than risk-free profit.

What appears to be a conversion opportunity usually isn't after accounting for all factors: (1) Transaction costs on three legs, (2) Expected dividends, (3) Current interest rates, (4) Your actual execution prices vs. displayed quotes. Professional traders have near-zero costs and can capture tiny mispricings; retail traders typically cannot.

You need to buy 100 shares of stock at full price (or 50% on margin). For a $200 stock, that's $20,000. You also need to buy the put (a few hundred to thousand dollars). You receive premium for selling the call, which partially offsets costs. Total capital is roughly the stock price × 100.

One of two things: If stock is below the strike, you exercise your put to sell your stock at the strike price. If stock is above the strike, your call is assigned and you deliver your stock at the strike price. Either way, you receive strike × 100 in cash, regardless of where the stock actually trades.

A conversion uses the SAME strike for the put and call - creating a risk-free arbitrage position. A collar uses DIFFERENT strikes - a lower put and higher call - providing a range of outcomes. A collar is a protective strategy; a conversion is an arbitrage strategy.

Subtract the present value of expected dividends from the theoretical C - P value. Only count dividends with ex-dates BEFORE option expiration. Use the formula: PV(Dividend) = Dividend × e^(-r × days to ex-date/365). Higher expected dividends make calls relatively cheaper and puts relatively more expensive.

Early assignment is most common when: (1) The call is deep in-the-money, (2) There's a dividend approaching (call holders exercise to capture it), (3) There's minimal time value remaining in the call. Pre-dividend assignment is the most common scenario. Monitor ITM calls closely as ex-dividend dates approach.

The implied rate is what you earn on your capital over the holding period. Formula: Implied Rate = [(Final Value / Initial Cost) - 1] × (365/DTE). If you pay $57,950 today and receive $58,000 in 60 days, Rate = [(58000/57950) - 1] × (365/60) = 0.53% annualized. Compare to risk-free rate to evaluate opportunity.

Rarely. The value is locked in, so there's usually no benefit to closing early except: (1) The mispricing reversed dramatically, making early exit profitable after costs, (2) You need the capital for a better opportunity. Transaction costs on early exit typically exceed any benefit.

Yes, but with more considerations: (1) More dividends to account for, (2) Greater interest rate sensitivity, (3) Larger capital commitment for longer, (4) Wider bid-ask spreads typically. LEAPS conversions tie up capital for longer periods, so the opportunity cost must be justified by the return.

Market makers use conversions to hedge accumulated inventory. When they fill customer orders, they accumulate directional exposure. A conversion neutralizes call inventory by buying stock and puts. This locks in the position, eliminating market risk while the maker waits for offsetting orders. Their low costs make even small locked-in profits worthwhile.

True persistent violations are rare but can occur due to: (1) Hard-to-borrow stocks where short selling is restricted, (2) Corporate actions creating option pricing complexity, (3) Dividend uncertainty or special dividends, (4) American exercise premium on deep ITM options. What appears to be mispricing is usually fair pricing with all factors included.

Some brokers with portfolio margin recognize conversions as riskless positions and require minimal margin. Others still require full margin on each component. Check with your broker - if conversions are recognized as riskless, capital efficiency improves dramatically, potentially making marginal opportunities profitable.

Both exploit put-call parity but differently. A conversion uses stock + options at one strike. A box spread uses options only at two strikes (bull call spread + bear put spread). A box is effectively a conversion at one strike combined with a reversal at another strike, with the stock positions canceling out.

Check the stock borrow rate through your broker. Calculate the implied borrow cost in the put-call spread. Formula: Apparent Mispricing = Observed (C-P) - Theoretical (C-P). Then: True Mispricing = Apparent Mispricing - Borrow Cost for your holding period. If True Mispricing < Transaction Costs, there's no real opportunity.