Risk in holding conversions/reversals to expiration?

Discussion in 'Options' started by TraDaToR, Feb 16, 2012.

  1. Hey Atticus, how are things? Glad to see you're keeping the people informed here, good job as always.

    Don
     
    #11     Feb 16, 2012
  2. I come across many conversion & reversal opportunities; however, the problem (as Don stated) is that there are merely pennies available. When you calculate the cost of the trade (i.e. portfolio margin rate + commissions) for the sheer volume needed to make the trade worthwhile, then the pennies of arbitrage opportunity are eaten up... NO FREE LUNCH (aaarrrrgh)!!

    Walt

     
    #12     Feb 16, 2012
  3. TraDaToR

    TraDaToR

    Exactly. Arbitrage opportunities are available, not only in options, but also in calendar spreads when there is no implied functionality or on contracts listed on several exchanges.

    If you run a scanner everyday, you will sure have some arbs available( manually in fact ), but the risk is high. Ex: For this conversion, I have a 5 ticks edge per conversion. 5 ticks is nothing on this contract if there is pinning and I end up without the offseting futures... Also when you try to do arbs, you often end up with illiquid instruments where it is hard to get in/out and there can be some unknown rules affecting the contract that will neglect your edge.

    I have been doing pure arbs for 5 years but I think the most I made out of it was like 7K$ one year, so it really is a marginal revenue generator.

    Once I did a 1K$ per contract arb though...
     
    #13     Feb 17, 2012
  4. When you said that conversions/reversals are also widespread today, do you mean that traders are trading conversions/reversals by using spread orders (so that all of the legs are filled or none of them is filled, without any execution risk)? Or basically trading conversions as arbitrage opportunities (as opposed to get out of positions) means legging into the conversion/reversal and therefore having a substantial execution risk? Thanks in advance for any clarifications, from you or other readers.
     
    #14     Feb 17, 2012
  5. rmorse

    rmorse Sponsor

    Options Market Makers are except from locates. That means they can sell stock short, in hard to borrow securities when others can't. For hedge funds or non broker dealers that are not except, that want to be short these securities for whatever reason, they can and do offer long stock for a fee through a conversion.
     
    #15     Feb 17, 2012
  6. Most option traders, on the floor and upstairs, look for nothing more than simple volatility variances. They will buy and sell calls and puts of various strikes and expirations, and then they will review their positions, categorize into long spreads, short spreads, straddles, strangles, all the basic stuff, and when reducing positions, they know they can to the 3way with a bank or institution to close out when appropriate.

    Don
     
    #16     Feb 17, 2012
  7. FSU

    FSU

    Dont think that is true Bob. If that was the case the MM would just load up on reversals and pocket the hard to borrow premium.
     
    #17     Feb 17, 2012
  8. So that means that they use conversion/reversal mainly for closing positions, not as pure arb opportunities?

    Also, is it possible to enter into arb opportunities such as boxes/conversions/reversals by using spread orders to eliminate execution risk (especially when implied pricing functionality exists) or it is not possible?
     
    #18     Feb 17, 2012
  9. What happens is the banks and other institutions who have a reason for wanting either long or short stock positions will "quote" (ask for quotes) a certain box or conversion, whatever. The MM's will decide among themselves a good price to do maybe 1,000 or more contracts, and "get into" a position with a slight edge. OR - they will do as I said above, and use the more "risk adverse" method to close out. Been that way since I was on the floor. A lot has changed, but as they say, "the more things change the more they remain the same."

    Have a great long weekend, I'm off to the Venetian for a poker tournament....

    Don :)
     
    #19     Feb 17, 2012