Risk Reversal
A risk reversal uses one call and one put to create a position that behaves like owning (or shorting) the stock — at low or zero upfront cost. You pay for one option by selling the other. The result is a strongly directional position with no defined maximum loss.
How a Risk Reversal Works
You buy an option on one side of the market and sell an option on the other. The premium you receive from selling offsets part or all of the cost of buying. If the strikes are chosen carefully, the position can be entered for near-zero net cost — but that cost-free entry comes with the full risk of an unhedged directional position.
Risk reversals are common in professional options trading as a way to express a directional view with minimal premium outlay. They're also used to hedge existing stock positions.
Bullish vs Bearish Risk Reversal
Bullish risk reversal (Synthetic Long): Buy an OTM call, sell an OTM put. You profit if the stock rises above the call strike. You lose if the stock falls below the put strike. The position behaves like owning the stock. If the put and call premiums match, you enter for zero cost — but you've taken on the full downside risk of being assigned shares if the stock falls below your short put strike.
Example: Stock at $100. Buy the $110 call for $2.00, sell the $90 put for $2.00. Net cost: $0. If the stock rises to $115, you profit $5 per share ($500). If it falls to $85, you lose $5 per share ($500) — and may be assigned 100 shares at $90.
Bearish risk reversal (Synthetic Short): Sell an OTM call, buy an OTM put. You profit if the stock falls below the put strike. You lose if the stock rises above the call strike. This behaves like shorting the stock, with the same unlimited upside risk.
Example: Stock at $100. Sell the $110 call for $2.00, buy the $90 put for $2.00. Net cost: $0. If the stock falls to $85, you profit $5 per share. If it rises to $115, you lose $5 per share on the short call — with no cap on further losses.
Maximum Profit, Maximum Loss, and Breakeven
Bullish risk reversal — Maximum profit: Unlimited. The long call captures all upside above the call strike.
Bullish risk reversal — Maximum loss: Substantial. The short put has risk down to zero (same as owning the stock at the put strike). If the net premium is zero, there's no cushion at all.
Bearish risk reversal — Maximum profit: Put strike minus net premium paid (capped by the stock reaching zero).
Bearish risk reversal — Maximum loss: Unlimited. The short call has no cap on the upside.
When to Use a Risk Reversal
You have a strong directional view and want low or zero premium outlay. If you're confident a stock will move significantly in one direction but don't want to pay for a call or put outright, the risk reversal lets you express that view by funding one side with the other.
You want to hedge a stock position at low cost. Owning 100 shares and buying a risk reversal (sell call, buy put) creates a collar that caps both upside and downside. If done at-the-money, the collar can be entered for near zero cost.
Implied volatility skew is in your favor. When OTM puts are more expensive than OTM calls (common in equity markets), a bullish risk reversal (buy call, sell put) benefits from that skew — you're selling the expensive side and buying the cheap side.
Frequently Asked Questions
Why is it called a "risk reversal"?
The name comes from derivatives trading. Selling a put and buying a call transfers the downside risk from the put seller to the buyer — reversing who bears the risk of a decline. It originated as a hedging tool for portfolio managers who wanted to protect gains without paying full put premium.
Is a risk reversal the same as a synthetic long position?
Yes. A bullish risk reversal (long call, short put at the same strike) with both options at-the-money exactly replicates owning the stock. The same delta, the same P/L profile — just constructed with options instead of shares.
What's the biggest risk of a risk reversal?
The short leg. In a bullish risk reversal, the short put can be assigned — you'd be forced to buy 100 shares at the put strike. In a bearish risk reversal, the short call has unlimited loss potential. These are not defined-risk strategies.