21. Box or Conversion / Reversal

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.