Reversal

A reversal is the mirror image of a conversion. Conversion: Long stock + Long put + Short call (used when calls are overpriced). Reversal: Short stock + Short put + Long call (used when puts are overpriced). Conversions require capital to buy stock; reversals require ability to borrow and short stock.

Reversals require short selling, which adds complexity: (1) Must find shares to borrow, (2) Must pay borrow fees that often exceed the apparent mispricing, (3) Face buy-in risk if lender recalls shares, (4) Short sale regulations may restrict timing. Conversions just require capital, which is simpler.

Because the cost to borrow and short the stock is high. Arbitrageurs would normally sell expensive puts and buy cheap calls while shorting stock. But if borrowing is expensive or impossible, this arbitrage can't happen, so puts stay expensive. The put premium reflects the borrow cost, not mispricing.

No. IRAs cannot have short stock positions and cannot sell naked puts. Reversals require both. You need a margin account with short selling and naked put approval, which IRAs don't allow.

You cannot execute a reversal without borrowing stock. If shares aren't available, there's no trade to make. This is why many apparent put mispricing opportunities can't be captured - the stock simply can't be shorted at any price.

Ask your broker directly or check their borrow availability tool. Rates are not publicly standardized. Interactive Brokers shows indicative rates in their SLB (Securities Lending and Borrowing) section. Be aware rates can change quickly and your actual rate may differ from indicative rates.

Your profits decrease. Unlike other costs which are fixed at entry, borrow is charged daily at the current rate. If you entered expecting 10% and it becomes 30%, your profit shrinks significantly. This risk is hard to hedge, though some brokers offer term borrows at fixed rates.

You must pay the dividend to the share lender on the ex-dividend date. This cost must be subtracted from your expected profit. On high-dividend stocks, this cost can be substantial. Additionally, puts become legitimately more expensive when dividends are expected, often explaining apparent mispricing.

Typically: Short stock margin (150% of stock value under Reg T, or 50% + borrowed amount) plus naked put margin. Combined requirements are substantial. Some brokers with portfolio margin may recognize the reversal as riskless and require less, but this varies by broker.

Consider early exit if: (1) The mispricing reversed favorably (puts become cheap relative to calls), (2) Borrow rate has increased making continued holding expensive, (3) Better use for the margin capital. Calculate total profit including remaining borrow costs vs early exit costs.

Market makers who fill customer put sell orders accumulate long put inventory with bullish exposure. They create reversals by shorting stock and buying calls against their existing puts, locking in their position. The goal is hedging, not arbitrage. Their cost advantages make even small locked-in values worthwhile.

True opportunities are rare and brief: (1) Flash crashes or market stress causing temporary dislocations, (2) Corporate actions like special dividends before options adjust, (3) Index rebalancing changing borrow dynamics, (4) Brief order flow imbalances. These windows are typically seconds to minutes.

Portfolio margin uses risk-based calculations. Since a reversal has zero market risk, PM may recognize this and require minimal margin. However, treatment varies by broker. Some may margin components separately, others may recognize the combination. Verify with your broker before relying on PM treatment.

Reg SHO requires: (1) Locate before shorting - broker must reasonably believe shares available, (2) Close-out requirements for fails, (3) Short sale price test (alternative uptick rule) during circuit breakers. Violations can result in penalties and forced position closure.

Build a system that: (1) Calculates theoretical parity for all options, (2) Compares to market prices, (3) Gets real-time borrow rates (challenging), (4) Calculates true mispricing after borrow and costs, (5) Filters for liquidity and executability. Expect very few actionable opportunities. Most apparent opportunities disappear after borrow adjustment.