Strategy reference
Risk Reversal
A risk reversal buys an out-of-the-money put and sells an out-of-the-money call. Standalone, it has a bearish payoff; pairing it with the underlying stock creates a "collar."
Structure
Buy one out-of-the-money put (strike below where the stock is trading) and sell one out-of-the-money call (strike above where the stock is trading), both expiring on the same date. The combined cost can be a small credit or a small debit depending on which side of the volatility skew you are trading.
Payoff at expiration
At expiration, three regions. Below the put strike, you gain dollar-for-dollar with downward moves in the stock. Between the two strikes, your profit equals the small credit or debit you started with. Above the call strike, you lose dollar-for-dollar with upward moves in the stock.
- Stock price
- $100
- Buy
- 1 × $95 put @ $1.50
- Sell
- 1 × $105 call @ $1.50
- Net cost
- $0.00 (zero-cost; depends on skew)
- Below $95
- Gains 1-for-1 with downward moves
- Between $95 and $105
- P&L = initial credit/debit
- Above $105
- Loses 1-for-1 with upward moves (unlimited)
Frequently asked questions
What is a risk reversal in options?
A risk reversal buys an out-of-the-money put and sells an out-of-the-money call, both expiring on the same date. Standalone it has a bearish synthetic-short payoff; paired with the underlying stock it forms a collar.
What is the maximum loss on a risk reversal?
Above the call strike, losses are unbounded because the short call is uncovered. Pairing the position with 100 shares of the underlying creates a capped-loss collar.
Is a risk reversal a credit or debit trade?
Either, depending on volatility skew. When the put is more expensive than the call (negative skew), it costs a debit; the reverse produces a credit.
This page is an educational reference, not investment advice. Numbers in the worked example are approximations for illustration only — real option prices depend on volatility, interest rates, dividends, and time to expiration. See the full disclaimer for details.