finance the long stock. This is proven mathematically by put-call parity.
Negative rho indicates a bearish position on the interest rate; the trader
wants it to go lower. Positive rho is a bullish interest rate position.
But a one-percentage-point change in the interest rate in one day is a big
and uncommon change. The question is: is rho relevant? That depends on
the type of position and the type of trader. A 0.090 rho would lead to a
0.0225 profit-and-loss (P&(L)) change per one lot conversion on a 25-basis-
point, or quarter percent, change. That’s just $2.25 per spread. This
incremental profit or loss, however, can be relevant to professional traders
like market makers. They trade very large positions with the aspiration of
making small incremental profits on each trade. A market maker with a
5,000-lot conversion would stand to make or lose $11,250, given a quarter-
percentage-point change in interest rate and a 0.090 rho.
The Mind of a Market Maker
Market makers are among the only traders who can trade conversions and
reversals profitably, because of the size of their trades and the fact that they
can buy the bid and sell the offer. Market makers often attempt to leg into
and out of conversions (and reversals). Given the conversion in this
example, a market maker may set out to sell calls and in turn buy stock to
hedge the call’s delta risk (this will be covered in Chapters 12 and 17), then
buy puts and the rest of the stock to create a balanced conversion: one call
to one put to one hundred shares. The trader may try to put on the
conversion in the previous example for a total of $0.50 over the price of the
long stock instead of the $0.46 it’s worth. He would then try to leg out of
the trade for less, say $0.45 over the stock, with the goal of locking in a
$0.05 profit per spread on the whole trade.
Reversal
A reversal, or reverse conversion, is simply the opposite of the conversion:
buy call, sell put, and sell (short) stock. A reversal can be executed to close
a conversion, or it can be an opening transaction. Using the same stock and
options as in the previous example, a trader could establish a reversal as
follows: