Lehman Brothers Common (LEH), $5 Calls (LYHDA) & $2.50 Puts (LYHPZ): Conversion Arbitrage Opportunity
Yesterday I noted these quotes for LEH, LYHDA and LYHPZ, respectively: $8.00, $6.10 (bid) and $0.69 (ask). For about 10 minutes it was possible to create a cheap synthetic position by buying the common in round lots and then selling calls and buying puts in corresponding amounts.
A decline in LEH to $1.90 will be fully offset by premium received from the short calls; any further decline will be offset by the puts. In a worst case scenario the investor will lose $9 per round lot, but his maximum gain is vastly disproportionate—$241. The mathematical expectation appears to be positive.
This type of conversion arbitrage is commonly practiced by market makers. It is not necessarily a violation of EMH since transaction costs tend to hinder everyone else.
