Reversal Arbitrage
Reversal arbitrage (often just called a "reversal") is an options-and-stock trade that tries to lock in a small, near risk-free profit when the pricing between a stock, a put, and a call gets slightly out of line. It is the mirror image of a "conversion" arbitrage, which is why the two are almost always mentioned together.
The mechanics: a trader sells the stock short (borrows shares and sells them, planning to buy them back later), sells (writes) a put, and buys a call. The put and call have the same strike price and same expiration date, and are on the same underlying stock. If you laid out the payoff of "short stock + short put + long call" at expiration, it should, in theory, always net to the same fixed result no matter where the stock price ends up — because the call and put are linked to the stock through a pricing relationship called put-call parity. When the actual market prices of the stock, put, and call drift away from what that parity relationship says they should be, a reversal can capture the difference as a small, locked-in edge.
The nuance that trips people up is the word "riskless." The position is only close to riskless in a frictionless world — no borrowing costs, no fees, unlimited stock to borrow, and prices staying at the levels you traded them at. In practice, the cost of borrowing shares to short, exchange and clearing fees, the interest you earn or pay on cash, and the risk of early assignment on the short put (since American-style options can be exercised before expiration) all eat into or can flip the supposed "free" profit. This is why reversals are almost exclusively the domain of market makers and professional options desks with very low transaction costs, not retail traders.
It's also worth separating this from a "reversal" in the everyday chart sense (a trend reversing direction). This entry is about the specific arbitrage structure, not a chart pattern.
This term depends on a rule or threshold that changes over time, so no specific figure is quoted here. This entry describes the general structure and logic of reversal arbitrage, which is stable, but does not assert specific figures like typical margin requirements, borrow rates, or fee levels since these vary by broker, market maker, and clearinghouse and change over time. A human should confirm any specific cost or margin figures against current broker/exchange/clearinghouse disclosures before publishing if such numbers are added.
A day trader won't typically run this strategy themselves — it requires cheap stock borrow and institutional-level execution costs — but understanding it explains why put, call, and stock prices tend to stay tightly linked intraday, which affects how options quotes move relative to the underlying.
Suppose a stock trades at $50, the 50-strike call is priced at $2.50, and the 50-strike put (same expiration) is priced at $2.10. Put-call parity says these prices, combined with the stock price and a small interest adjustment, should balance out. If the put looks slightly overpriced relative to the call and stock, a professional trader could short the stock at $50, sell the put for $2.10, and buy the call for $2.50, locking in a small edge once financing and borrow costs are accounted for — regardless of whether the stock later rises or falls.
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