How does a risk-reversal option strategy work and when is it used?

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AcadiFi · Accepted Answer

A risk-reversal combines a long out-of-the-money call with a short out-of-the-money put (bullish version) on the same underlying and expiry. The short put finances the long call, often making the structure zero-cost or slightly credit. Consider a stock at $100: buy the 110 call for $2.50 and sell the 90 put for $2.40. Net cost is $0.10. If the stock rallies past 110 you capture unlimited upside; if it falls below 90 you are obligated to buy at 90, effectively synthetic long. Between 90 and 110 the position expires worthless. In FX markets, the risk-reversal is quoted as the implied volatility differential between the equivalent-delta call and put, which measures skew. A positive 25-delta risk-reversal on EURUSD means EUR calls are pricier than EUR puts, signaling bullish positioning. ```mermaid flowchart LR A[Sell OTM Put
90 strike] --> C[Risk Reversal] B[Buy OTM Call
110 strike] --> C C --> D[Synthetic Long
Zero Cost] ``` Use risk-reversals when you have a directional conviction but want to minimize premium outlay. The trade-off is assignment risk on the short put—you can be forced long at the put strike during a selloff. Risk-reversals are ideal for corporate hedgers monetizing a natural long position in the underlying.

How does a risk-reversal option strategy work and when is it used?

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