642 Part V: Index Options and Futures 
exercise it; or is there too great a chance that OEX will rally and wipe out his dis­
count? 
If he buys this put when there is very little time left in the trading day, it might 
be enough of a discount. Recall that a one-point move in OEX is roughly equivalent 
to 15 points on the Dow (while a one-point move in SPX is about 7.5 Dow points). 
Thus, this O EX discount of 0.4 7 is about equal to 7 Dow points. Obviously, this is not 
a lot of cushion, because the Dow can easily move that far in a short period of time, 
so it would be sufficient only if there are just a few minutes of trading left and there 
were not previous indications oflarge orders to buy "market on close." 
However, if this situation were presented to the discounter at an earlier time in 
the trading day, he might defer because he would have to hedge his position and that 
might not be worth the trouble. If there were several hours left in the trading day, 
even a discount of a full point would not be enough to allow him to remain unhedged 
(one full OEX point is about 15 Dow points). Rather, he would, for example, buy 
futures, buy OEX calls, or sell puts on another index. At the end of the day, he could 
exercise the puts he bought at a discount and reverse the hedge in the open market. 
CONVERSIONS AND REVERSALS 
Conversions and reversals in cash-based options are really the market basket hedges 
(index arbitrage) described in Chapter 30. That is, the underlying security is actually 
all the stocks in the index. However, the more standard conversions and reversals can 
be executed with futures and futures options. 
Since there is no credit to one's account for selling a future and no debit for buy­
ing one, most futures conversions and reversals trade very nearly at a net price equal 
to the strike. That is, the value of the out-of-the-money futures option is equal to the 
time premium of the in-the-money option that is its counterpart in the conversion or 
reversal. 
Example: An index future is trading at 179.00. If the December 180 call is trading 
for 5.00, then the December 180 put should be priced near 6.00. The time value pre­
mium of the in-the-money put is 5.00 (6.00 + 179.00 - 180.00), which is equal to the 
price of the out-of-the-money call at the same strike. 
If one were to attempt to do a conversion or reversal with these options, he 
would have a position with no risk of loss but no possibility of gain: A reversal would 
be established, for example, at a "net price" of 180. Sell the future at 179, add the 
premium of the put, 6.00, and subtract the cost of the call, 5.00: 179 + 6.00 - 5.00 = 
180.00. As we know from Chapter 27 on arbitrage, one unwinds a conversion or 
reversal for a "net price" equal to the strike. Hence, there would be no gain or loss 
from this futures reversal.