What is a Conversion?
Provides the underlying stock position.
The same-strike option pair locks the stock's expiration value near the strike.
Core structure
| Leg | Action | Example |
|---|---|---|
| 1 | Buy / Own Stock | 100 shares |
| 2 | Buy to Open Put | $100 strike |
| 3 | Sell to Open Call | $100 strike |
The put and call use the same strike and expiration.
Worked example
Assume:
- Stock price = $100
- Buy $100 Put for $4.00
- Sell $100 Call for $4.00
Why the expiration value is fixed
| Stock at Expiration | What Happens? | Approximate Ending Value |
|---|---|---|
| $70 | The long put protects the shares near $100 | $10,000 |
| $100 | Both options finish near the strike | $10,000 |
| $130 | The short call can result in shares being sold at $100 | $10,000 |
Where does profit come from?
The profit does not come from stock direction. It comes from whether the combined stock and option prices are mispriced relative to fair value.
Interest rates, dividends, execution costs, and exercise style matter when deciding whether an apparent edge is real.
Conversion and put-call parity
A Conversion is a practical expression of put-call parity. If the pricing relationship is materially out of line, an arbitrage opportunity may exist in theory.
Conversion vs. Collar
| Feature | Conversion | Collar |
|---|---|---|
| Own stock | Yes | Yes |
| Long put | Same strike as call | Usually lower strike |
| Short call | Same strike as put | Usually higher strike |
| Purpose | Arbitrage / fixed payoff | Risk management |
| Upside retained | Essentially none above strike | Some, up to call strike |
Dividends and assignment
Because the strategy owns stock, dividend expectations affect its economics. The short call can also be assigned early.
Execution costs matter
Pros and cons
- Creates a nearly fixed expiration payoff.
- Useful for arbitrage and put-call parity analysis.
- Stock direction is largely irrelevant at expiration.
- Clear financing relationship.
- Requires stock plus two option legs.
- Short-call assignment risk.
- Dividend effects can complicate the trade.
- Execution costs can erase small edges.
- Tax treatment can be complex.
How to close it
Common mistakes
- Assuming the trade is automatically risk-free.
- Ignoring dividends and early assignment.
- Failing to include commissions and bid-ask spreads.
- Using market orders on the options.
- Treating it as a bullish investment rather than a pricing relationship.
Beginner checklist
| Check | Question |
|---|---|
| ☐ Strike | Are the put and call using the same strike and expiration? |
| ☐ Locked value | What is Strike x 100 at expiration? |
| ☐ Net cost | What is my stock cost plus net option premium? |
| ☐ Dividends | Is an ex-dividend date inside the trade? |
| ☐ Assignment | Could the short call be assigned early? |
| ☐ Costs | Does any apparent edge survive trading costs? |
| ☐ Purpose | Am I using this for arbitrage/financing rather than direction? |
Key takeaway
The option pair converts the stock into a nearly fixed expiration value.
The opportunity, if any, comes from pricing differences, interest rates, dividends, and execution quality—not from predicting whether the stock rises or falls.