"Working on the Daniels Execution Desk mandates that I bring every ounce of my industry experience to the front line every day. For me, I thrive on another day in the trench where seconds count."
– Daniel Blair
Execution Desk Specialist
21. Box or Conversion / Reversal
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Scenario:
This trader wants to take advantage of mis-pricing between futures and options. There are many ways that combinations of futures and/or options can generate a locked-in profit from mis-pricing. In this case, though, the synthetic long futures (long call + short put at same strike) is cheaper than the underlying futures. This trader can buy the synthetic futures and sell the actual futures to lock in a profit equal to the mis-pricing.
Specifics:
| Underlying Futures Contract: | February Pork Bellies | |
| Futures Price Level: | 68.30 | |
| Days to Futures Expiration: | 35 | |
| Days to Options Expiration: | 10 | |
| Option Implied Volatility: | Call = 34%; Put 37.5% | |
| Option Position: | Long 1 Feb 68 Call | - 1.675 ($670.00) |
| Short 1 Feb 68 Put | + 1.550 ($620.00) x 2 | |
| - 0.125 ($ 50.00) | ||
| Long: Synthetic Futures | 68.125 | |
| Short 1 Feb Futures | 68.300 | |
| Locked-In Profit | +0.175 ($ 70.00) |
At Expiration:
Profit is "locked in" with amount received equal to the 0.175 ($70) less commission costs.
Things to Watch:
Rarely will the mis-pricing be great enough for off-floor traders to capitalize on it. Unwinding the position can create problems if all of the positions are not liquidated at exactly the same time. Also, be aware of the possible forced early assignment of the short option.
MENU - Futures Strategy Guide
Contents Courtesy of CME.com