What is a Reverse Conversion?
Creates the underlying short-stock position.
The same-strike option pair offsets the short stock's expiration exposure.
Core structure
| Leg | Action | Example |
|---|---|---|
| 1 | Short Stock | 100 shares |
| 2 | Sell to Open Put | $100 strike |
| 3 | Buy to Open Call | $100 strike |
The put and call use the same strike and expiration.
Worked example
Assume:
- Stock price = $100
- Short 100 shares at $100
- Sell $100 Put for $4.00
- Buy $100 Call for $4.00
Why the payoff is nearly fixed
| Stock at Expiration | What Happens? | Economic Effect |
|---|---|---|
| $70 | Short put is assigned / valuable against short stock | Exposure is effectively locked near $100 |
| $100 | Both options finish near the strike | Exposure remains near the strike value |
| $130 | Long call protects against short-stock upside loss | Exposure is effectively capped near $100 |
Where does profit come from?
As with a Conversion, the goal is not directional prediction. The opportunity comes from pricing discrepancies relative to fair value.
Borrow costs, dividends, interest rates, option prices, and transaction costs determine whether an apparent edge is genuine.
Reverse Conversion and put-call parity
This is the opposite side of the same put-call parity relationship used in a standard Conversion.
Reverse Conversion vs. Conversion
| Feature | Reverse Conversion | Conversion |
|---|---|---|
| Stock position | Short stock | Long stock |
| Put | Short | Long |
| Call | Long | Short |
| Primary purpose | Arbitrage / financing | Arbitrage / financing |
| Directional exposure at expiry | Minimal | Minimal |
Stock borrow matters
Unlike a Conversion, the Reverse Conversion requires shorting shares.
A hard-to-borrow stock can make an apparent arbitrage opportunity unattractive or impossible to execute.
Dividends matter
A short seller may be responsible for payments equivalent to dividends distributed while the short position is open.
Assignment and exercise risk
The short put may be assigned before expiration, while the long call may be exercised when appropriate.
Execution costs matter
Pros and cons
- Creates a nearly fixed expiration payoff.
- Useful for arbitrage and put-call parity analysis.
- Stock direction becomes largely irrelevant at expiration.
- Can reveal implied financing or borrow relationships.
- Requires shorting stock.
- Borrow fees can be significant.
- Short-put assignment risk.
- Dividend obligations can complicate economics.
- Execution and tax treatment can be complex.
How to close it
Close carefully so temporary directional exposure does not appear unexpectedly.
Common mistakes
- Ignoring stock borrow fees.
- Assuming shares will remain borrowable for the life of the trade.
- Ignoring dividend obligations.
- Failing to include commissions and bid-ask spreads.
- Assuming the trade is automatically risk-free.
- Treating the setup as a bearish directional trade.
Beginner checklist
| Check | Question |
|---|---|
| ☐ Same strike | Are the call and put using the same strike and expiration? |
| ☐ Borrow | Are shares available to short, and at what borrow cost? |
| ☐ Dividends | Will I owe dividend-equivalent payments? |
| ☐ Net proceeds | What do I receive after all option and stock transactions? |
| ☐ Assignment | Could the short put be assigned early? |
| ☐ Costs | Does any apparent edge survive borrow fees and trading costs? |
| ☐ Taxes | Do I understand the tax treatment? |
| ☐ Purpose | Am I using this for arbitrage/financing rather than direction? |
Key takeaway
It is the mirror image of a Conversion and is designed to create a nearly fixed expiration payoff.
The real challenge is not forecasting the stock. It is understanding borrow costs, dividends, assignment, financing, taxes, and execution quality.