32 lines
1.9 KiB
Plaintext
32 lines
1.9 KiB
Plaintext
Conversions and Reversals
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When calls and puts are combined to create synthetic stock, the main
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differences are the interest rate and dividends. This is important because the
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risks associated with interest and dividends can be isolated, and ultimately
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traded, when synthetic stock is combined with the underlying. There are
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two ways to combine synthetic stock with its underlying security: a
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conversion and a reversal.
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Conversion
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A conversion is a three-legged position in which a trader is long stock, short
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a call, and long a put. The options share the same month and strike price.
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By most metrics, this is a very flat position. A trader with a conversion is
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long the stock and, at the same time, synthetically short the same stock.
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Consider this from the perspective of delta. In a conversion, the trader is
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long 1.00 deltas (the long stock) and short very close to 1.00 deltas (the
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synthetic short stock). Conversions have net flat deltas.
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The following is a simple example of a typical conversion and the
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corresponding deltas of each component.
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Short one 35-strike call:−0.63 delta
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Long one 35-strike put:−0.37 delta
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Long 100 shares: 1.00 delta
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0.00 delta
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The short call contributes a negative delta to the position, in this case,
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−0.63. The long put also contributes a negative delta, −0.37. The combined
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delta of the synthetic stock is −1.00 in this example, which is like being
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short 100 shares of stock. When the third leg of the spread is added, the
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long 100 shares, it counterbalances the synthetic. The total delta for the
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conversion is zero.
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Most of the conversion’s other greeks are pretty flat as well. Gamma,
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theta, and vega are similar for the call and the put in the conversion,
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because they have the same expiration month and strike price. Because the
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trader is selling one option and buying another—a call and a put,
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respectively—with the same month and strike, the greeks come very close |