Risk Reversal Strategy

What is a Risk Reversal?

A risk reversal is a two-leg options strategy that creates directional exposure by combining a long option with a short option on opposite sides of the current price. The most common form is the bullish risk reversal: sell an OTM put and use the premium to buy an OTM call.

Example: AAPL at $185. Sell the $175 put for $3.50, buy the $195 call for $3.50. Net cost: $0. If AAPL rises above $195, you profit dollar-for-dollar. If AAPL drops below $175, you lose dollar-for-dollar (like owning stock). Between $175-$195, both options expire worthless.

Why institutions use this: Zero-cost entry with unlimited upside. It is functionally similar to buying stock but without deploying capital for the shares. The tradeoff is the short put obligation below your put strike.

When to Use a Risk Reversal

Bullish Risk Reversal

• Strong bullish conviction: You believe the stock will rally and are willing to own it if it drops
• Capital efficiency: Want stock-like exposure without deploying full capital
• High put IV skew: When puts are more expensive than calls (common in most stocks), the put premium easily funds the call

Bearish Risk Reversal

Reverse the structure: buy an OTM put, sell an OTM call. You profit from declines, funded by the call sale. This caps your upside (short call obligation) but gives you free downside exposure.

Profit & Loss Scenarios

Setup: NVDA at $130. Sell $120 put for $4.50, buy $140 call for $4.50. Net cost: $0.

NVDA rallies to $160

Call worth $20.00. Put worthless. Profit: $2,000 on zero invested capital.

NVDA flat at $130

Both options expire worthless. Net result: $0. No harm, no foul.

NVDA drops to $100

Put obligation: buy at $120, stock at $100. Loss: $2,000. This is the risk: you have stock-like downside below the put strike.

Key Takeaways