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Define: Conversion / Reversal Arbitrage

Conversion / Reversal Arbitrage is a way of making risk free profit from mispriced options that results in the value of a synthetic position being significantly different from its actual position.

Conversion / Reversal arbitrage follows the usual rule of arbitraging; Buying the Cheap and Selling the Expensive. If the synthetic position is significantly higher in value than the actual position, then Conversion is done by buying the stock to synthetically close out the overpriced short synthetic position. If the stock is significantly higher in value than the synthetic position, then reversal is done by shorting the stock and buying the synthetic equal.

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