RISK REVERSAL
Overview
Sell an OTM put and buy an OTM call in the same expiration. Creates bullish exposure for little or no net premium — the put credit funds the call purchase. Similar to a synthetic long stock but with a gap between the strikes, creating a neutral zone where neither option profits or loses.
What it does
A risk reversal sells an OTM put and buys an OTM call — often for zero or near-zero net cost, because put skew makes puts more expensive than calls of equal distance. You gain bullish exposure to the upside (via the long call) funded entirely by downside risk you accept (via the short put). It's like a synthetic long stock but with a gap zone between the strikes where you have no position.
Structure
sell 1 OTM put + buy 1 OTM call
Setup
- 1.Sell 1 OTM Put (below current price).
- 2.Buy 1 OTM Call (above current price).
- 3.Same expiration.
Max profit
Unlimited above the call strike.
Max loss
Substantial below the put strike (down to zero). The short put has significant downside if the stock falls sharply.
Breakeven
Above: Call Strike + Net Debit (or − Net Credit). Below: Put Strike − Net Credit.
When to use
When you're bullish and want leveraged upside funded by selling put premium. Works well when put skew is elevated.
When to avoid
If you can't tolerate the assignment risk and substantial downside loss potential of the short put.
Example trade
Stock: SPY at $430 (bullish thesis) Sell 1 SPY $415 Put (5% OTM) at $3.50 Buy 1 SPY $445 Call (3.5% OTM) at $3.50 Net Cost: $0.00 (zero-cost risk reversal!) If SPY rises to $460: Call profit = $15 × 100 = $1,500 If SPY stays at $430: Both expire worthless; $0 P&L If SPY falls to $400: Short put loss = ($415 - $400) × 100 = -$1,500 If SPY falls to $380: Loss = ($415 - $380) × 100 = -$3,500
Common mistakes
- ×Treating a zero-cost risk reversal as a 'free' trade — the short put has real, substantial loss potential.
- ×Not accounting for assignment risk on the short put if it goes deeply ITM.
- ×Using on stocks with high borrow fee or pending binary events where the downside is severe.
- ×Not having stop-loss rules — below the put breakeven, losses compound quickly.
- ×Forgetting the neutral zone: the position has zero P&L while the stock stays between the two strikes.
FAQ
Why is a risk reversal often entered for zero cost?
Put-call skew — OTM puts are typically more expensive than OTM calls at equal distance. Selling the more-expensive put and buying the cheaper call often nets zero or a credit.
How is a risk reversal different from a synthetic long stock?
A synthetic long uses ATM strikes — it has stock-like exposure immediately. A risk reversal uses OTM strikes with a gap in between, creating a neutral zone where neither option is in play.