Conversions and Reversals
I am paraphrasing from Charles Cottles 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.
I am paraphrasing from Charles Cottles 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.
