Reverse Conversion

Reverse Conversion

A finance and risk management technique based on a put-call parity strategy that consists of selling a put and buying call (a synthetic long position), while shorting the underlying stock. As long as the put and call have the same underlying, strike price and expiration date, a synthetic long position will have the same risk/return profile as ownership of an equivalent amount of the underlying stock.

Notes:

In a typical reverse-conversion transaction, a brokerage firm short sells stock and hedges this position by buying its call and selling its put. Whether the brokerage firm makes money depends on the borrowing cost of the shorted stock and the put and call premiums, all of which may render a return better than the money market with very low risk. In the context of futures markets, a trader would be synthetically long and short the underlying futures while looking for arbitrage opportunities.

See also: Arbitrage, Call Option, Expiration Date, Put-Call Parity, Put Option, Short Selling, Strike Price, Synthetic, Underlying

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Reverse conversion

A technique in which brokerage firms earn interest on the stocks they hold for their customers by selling the short and investing the proceeds in money market accounts. The short positions are hedged to protect against adverse market conditions.