Conversion / Reversal Strategy for Retail Trader
- Thread starter ET180
- Start date
I was just looking for a way to make $7 on $3500 of capital relatively risk-free in about a one-week period. If one does that every week for a year, that will generate a 10.4% annual return which is better than the average annual rate of return on the S&P500...which beats most fund managers. Even if I can only make $4 on $3500 in one week, that's still a 6% annual return. So I was just curious if any retail traders here trade conversions or reversals with that goal in mind. I'm not advocating this strategy as the best way to trade. But there are times when I want less risk and perhaps this has the potential to generate some income with idle cash.
How do you figure you can earn 7 a week on a conversion with 3500?
Can you show an example?
Can you show an example?
Sure,
Here's a screenshot of HESS Corp taken around 3:30 New York Time. The stock is trading at 37 and the bid-ask spreads on the options are wide. I'm usually able to buy or sell an ATM strike option by accepting / paying a premium in the middle of the spread. If that holds true for this case, then a 37 put can be traded at (1.46 + 1.05) / 2 = 1.26 and a 37 call can be traded for (2.12 + 1.07) / 2 = $1.60. If that's the case, then I want to sell a call and buy the put which implies putting on a conversion. So I sell a call for $1.60 of premium, buy the put for $1.26 and go long 100 shares of the stock. In that case, I collect (1.60 - 1.26) = $0.34 / sh or a $34 return on $3700 in just a few days.
Due to put-call parity, there's no way that the difference in premium between an ATM call and put for same duration can be that wide. However, even if it's just a few dollars, that can provide a good nearly risk-free return. But I'm not sure how to execute the strategy. I'd only want to buy the put if I can sell the call for some minimum amount of premium which is a function of the stock price. The problem is that I don't know how much a buyer would pay for a call or a seller would accept for a put. It might be a good strategy if you're planning to buy a call or put anyway for another reason. Then see if you can collect enough premium for the complimentary option to create a conversion / reversal. It would have to be an automated strategy.
Here's a screenshot of HESS Corp taken around 3:30 New York Time. The stock is trading at 37 and the bid-ask spreads on the options are wide. I'm usually able to buy or sell an ATM strike option by accepting / paying a premium in the middle of the spread. If that holds true for this case, then a 37 put can be traded at (1.46 + 1.05) / 2 = 1.26 and a 37 call can be traded for (2.12 + 1.07) / 2 = $1.60. If that's the case, then I want to sell a call and buy the put which implies putting on a conversion. So I sell a call for $1.60 of premium, buy the put for $1.26 and go long 100 shares of the stock. In that case, I collect (1.60 - 1.26) = $0.34 / sh or a $34 return on $3700 in just a few days.
Due to put-call parity, there's no way that the difference in premium between an ATM call and put for same duration can be that wide. However, even if it's just a few dollars, that can provide a good nearly risk-free return. But I'm not sure how to execute the strategy. I'd only want to buy the put if I can sell the call for some minimum amount of premium which is a function of the stock price. The problem is that I don't know how much a buyer would pay for a call or a seller would accept for a put. It might be a good strategy if you're planning to buy a call or put anyway for another reason. Then see if you can collect enough premium for the complimentary option to create a conversion / reversal. It would have to be an automated strategy.
You will NEVER get a decent price in a thin option chain with spreads that wide. Dude, you need order flow to make this work so you can buy on the bid or sell on the offer. No market maker is going to middle that spread and trade at fair value. He doesn't have to. You a retail trader to take the other side of your order at bad prices and you need them to do at the exact same time so you get filled on the conversion strike otherwise you are legging the trade. There is a million to one chance of that happening.
How does order flow allow one to buy on the bid and sell at the ask?
Market makers earn the spread when quoting liquid issues. In liquid issues, retail traders have priority over market makers and therefore can get filled ahead of mm's on the bid and offer. Conversions and reversals were done on the floor in the old days partly because spreads were so wide and they earned the spread.