Risk Reversal
A long OTM call plus a short OTM put at different strikes; skews risk to one side at low cost.
Profit / Loss Diagram
Risk Reversal (Bull) at expiration
What is this strategy?
The Risk Reversal is a bullish (or bearish) strategy creating exposure similar to a synthetic long but with a strike structure that typically generates a net credit. It is built by buying 1 OTM call for the upside and selling 1 OTM put for the downside, with the strikes separated. Unlike the synthetic long where both strikes are equal, the risk reversal places the put at a lower strike and the call at a higher one, creating a range where you have no exposure but outside which you do.
The appeal of the Risk Reversal is that it typically generates a net credit at entry: the premium received on the put exceeds the premium paid for the call, especially when put skew is pronounced. That means money in your pocket from the start. But you take on risk: if price falls below the put strike you lose money, and if it rises above the call strike you gain without limit. It is a directional bet at low or negative cost.
The Risk Reversal is popular among directional traders who hold a clear bullish or bearish view but do not want to pay significant premium for outright options. It is especially effective when implied volatility is high, so the sold put commands good premium, or when an upcoming event can be exploited. Many professional traders use risk reversals to take directional positions at low cost, or even to be paid for taking them.
Construction
| Action | Instrument | Strike | Expiration | Example |
|---|---|---|---|---|
| SELL | 1 Put | OTM (2-3% below) | 30-60 DTE | -1 SPY Nov 415 Put |
| BUY | 1 Call | OTM (2-3% above) | 30-60 DTE | +1 SPY Nov 435 Call |
Example
Scenario: SPY at $427. Moderately bullish but you do not want to pay for an outright call.
- Put Sold -1 SPY Nov 415 Put @ $2.50
- Call Purchased +1 SPY Nov 435 Call @ $1.50
- Net Credit +$100 (250 − 150)
- Maximum Gain Unlimited on the upside, plus the credit collected
- Maximum Loss $41,400 (415 × 100 − $100 credit), if SPY falls to zero
- Breakeven $414.00 (415 strike − 1.00 credit per share)
- Zone Between Strikes Between $415 and $435 you keep exactly the $100 credit
- Profit if SPY = $450 $1,600 ($1,500 from the call + $100 credit)
The Greeks
The long call’s positive delta minus the short put’s negative delta leaves a net bullish delta.
The long call’s negative theta slightly exceeds the short put’s positive theta. Time works marginally against you.
The long call’s positive vega is not fully offset by the short put’s negative vega. Rising IV helps slightly.
The long call’s positive gamma exceeds the short put’s negative gamma, accelerating gains on upward moves.
Position Management
- 01 Set Your Comfort Range Define before opening: how far down can I let it fall (the put strike) and how high do I expect it to rise (the call strike)? Make sure both are realistic.
- 02 Take Profits on a Rally If SPY rises significantly, close the position to bank gains. Do not wait for an unlimited move; pullbacks happen.
- 03 Manage the Put if Price Falls If SPY approaches 415, your put is at risk. You can close the whole position or roll the put to a lower strike to reduce risk.
- 04 Monitor Volatility High IV helps initially, since you collected a good credit. If IV falls afterwards, your put loses value (good) but so does your call (bad). Net effect is small.
- 05 Use Ahead of Bullish Events Risk reversals work well before expected bullish news — an earnings beat, a product launch. Use them to exploit events at low cost.