254 Part Ill: Put Option Strategies 
A conversion position has no risk. The arbitrageur will do three things: 
1. Buy 100 shares of the underlying stock. 
2. Buy 1 put option at a certain striking price. 
3. Sell l call option at the same striking price. 
The arbitrageur has no risk in this position. If the underlying stock drops, he can 
always exercise his long put to sell the stock at a higher price. If the underlying stock 
rises, his long stock offsets the loss on his short call. Of course, the prices that the 
arbitrageur pays for the individual securities determine whether or not a conversion 
will be profitable. At times, a public customer may look at prices in the newspaper 
and see that he could establish a position similar to the foregoing one for a profit, 
even after commissions. However, unless prices are out of line, the public customer 
would not normally be able to make a better return than he could by putting his 
money into a bank or a Treasury bill, because of the commission costs he would pay. 
Without needing to understand, at this time, exactly what prices would make an 
attractive conversion, it is possible to see that it would not always be possible for the 
arbitrageur to do a conversion. The mere action of many arbitrageurs doing the same 
conversion would force the prices into line. The stock price would rise because arbi­
trageurs are buying the stock, as would the put price; and the call price would drop 
because of the preponderance of sellers. 
When this happens, another arbitrage, known as a reversal ( or reverse conver­
sion), is possible. In this case, the arbitrageur does the opposite: He shorts the under­
lying stock, sells 1 put, and buys 1 call. Again, this is a position with no risk. If the 
stock rises, he can always exercise his call to buy stock at a lower price and cover his 
short sale. If the stock falls, his short stock will offset any losses on his short put. 
The point of introducing this information, which is relatively complicated, at 
this place in the text is to demonstrate that there is a relationship between put and 
call prices, when both have the same striking price and expiration date. They are not 
independent of one another. If the put becomes "cheap" with respect to the call, arbi­
trageurs will move in to do conversions and force the prices back in line. On the other 
hand, if the put becomes expensive with relationship to the call, arbitrageurs will do 
reversals until the prices move back into line. 
Because of the way in which the carrying cost of the stock and the dividend rate 
of the stock are involved in doing these conversions or reversals, two facts come to 
light regarding the relationship of put prices and call prices. Both of these facts have 
to do with the carrying costs incurred during the conversion. First, a put option will 
generally sell for less than a call option when the underlying stock is exactly at the 
striking price, unless the stock pays a large dividend. In the older over-the-counter