Posted in Finance, Accounting and Economics Terms, Total Reads: 335
Definition: Conversion Option
Conversion Option refers to the conversion from one investment vehicle to another. Under the conversion option convertible bond is converted into common stock, adjustable-rate mortgage is converted into fixed rate mortgage. Conversion Option is also applied to options market in which one can earn riskless profit.
In case of convertible bond, a bondholder have a right to convert the bond into specified number of common stock of an issuing company after specified period of time. Sometimes conversion option is given to preferred stock also in which preferred shares can be converted into a specified number of common stock.
Adjustable Rate Mortgages (ARM) come with a conversion option or without a conversion option. Adjustable rate in ARM refers to floating rate of interest which is adjusted periodically as per the market. ARM having conversion option are costlier than ARM not having conversion option. ARM having conversion option can be converted into fixed rate conversion option within a certain period of time or after a certain period of time.
In options market, conversion option refers to options arbitrage. Under options arbitrage, when options become overpriced, options holder purchase underlying stock to earn a profit and vice-versa.
So conversion option gives an opportunity to earn profit without risk by buying or selling underlying securities of options.