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| Discuss Conversions & Reversals- How you can benefit at the Options within the Traderji.com - Discussion forum for Stocks Commodities & Forex; Conversions and Reversals I am paraphrasing from Charles Cottle’s seminal work- in explaining the ... |
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#1
3rd September 2007, 01:37 AM
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Conversions & Reversals- How you can benefit
Conversions and Reversals
I am paraphrasing from Charles Cottle’s seminal work- in explaining the nitty gritty. The most important thing is that with options you need to keep changing with the market- there are some basics to be covered. More details will be in his book titled Woulda, Coulda Shoulda- Not sure if it is a free download – form www.Cashflowheaven.Com- but you can try! Conversion A conversion is Nothing but A long underlying, A long Put and A short Call- ALL at the same strike price and at the same expiration. If you designate Underlying as U , a Put as P and a Call as C Then a Conversion is +U + P – C ( same expiration and strike price) Reversal A reversal us exact opposite of the Conversion I.e. a Reversal is -U-P +C ( Same expiration and strike price) If 2 parties end up trading this spread with each other at “fair Value” There will be no profit or loss. So if this happens at fair Value we will have U +P –C = 0 Or -U – P + C = 0 This leads us to the Put Call parity- and I would urge you to read it up. These may sound very esoteric- but Remember the Acronym CUP If things are traded at fair Value- and this happens in a liquid market ( LOL!) C= U +P ( same strike and expiration) So if you buy a call - it is the same as being long the underlying and a long put ( at same strike as the call, same expiration). This is very useful- as now you can look at your situation in different Equivalent positions! Imagine a triangle with C, U and P at the vertices. ( Same strike , same expiration) So if you are long a PUT – it is exactly the same as Being Long a call at the same strike ( same expiration) and short the Underlying. So these are the basics C = U +P P= C –U U= C –P Note options are at the same strike and expiration. Understand this, and then you will form a good idea of how to change and adapt your current position. Another important discussion is called the "box"- and I will post a separate article. 
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