Risk Reversal Strategy

Similar but not identical. Synthetic long uses ATM options and has delta of +1.00 (like stock). Risk reversal uses OTM options, has lower delta (+0.50 to +0.70), and has a 'dead zone' between strikes where both options expire worthless.

Both options expire worthless. If you entered for a credit, you keep that credit as profit. If you paid a debit, you lose that amount. The range between strikes is the 'dead zone' where neither option has intrinsic value at expiration.

Yes. The short put requires margin since you may be assigned and forced to buy shares. The margin is similar to a cash-secured put - typically 20-25% of the underlying value. You need Level 3 options approval at most brokers.

Yes, risk reversals don't require stock ownership. They create synthetic exposure. However, if assigned on the put, you'll need to buy shares or manage the assignment. This is different from a collar which requires owning stock first.

Risk reversal requires less capital (only margin vs full stock price), often has zero cost entry, and provides leveraged exposure. Trade-offs: no dividends, dead zone limits profits in that range, and you face potential assignment which requires capital.

Equidistant strikes (same % OTM) provide balanced exposure. Technical level strikes (put at support, call above resistance) align with price action. Use technical levels when they're clear; default to equidistant or delta-based (25-delta) when technicals are unclear.

Time decay is nearly neutral. The short put generates positive theta (decay helps you) while the long call has negative theta (decay hurts you). These roughly offset. This makes risk reversals more forgiving than pure long options which suffer from decay.

Roll when your directional thesis is intact but need more time or better strikes. Close when thesis changes or you've hit your target. Roll the put down if stock declines toward put strike. Roll the call up to extend profits if stock rallies through call strike.

Yes. Delta hedging (selling shares against the position) removes directional exposure, leaving you with pure skew exposure. This is how institutions trade skew mean-reversion. However, delta hedging requires active management and incurs trading costs.

Bearish risk reversal buys the put and sells the call (opposite of bullish). Due to skew, bearish RR usually requires a debit (buying expensive puts, selling cheap calls). It's used to profit from decline or hedge upside exposure.

Institutions enter delta-hedged risk reversals when skew is extreme (puts very expensive vs calls). They profit from skew normalization rather than direction. Systematic strategies targeting the 80th percentile skew entry and 50th percentile exit generate consistent risk-adjusted returns.

Risk reversal prices (skew) reflect supply/demand for puts vs calls. Steep skew (expensive puts) indicates fear/protection demand. Flat skew indicates complacency. Extreme skew levels often serve as contrarian indicators - extreme fear precedes rallies.

Add risk reversals to equity portfolios to increase market exposure without additional capital. Sell index puts, buy index calls. This adds leveraged beta exposure. The credit received adds carry. Risk: Must absorb losses in market declines.

A seagull adds a sold call above the long call (creating a call spread). This caps upside but generates additional credit, potentially creating a larger net credit or reducing cost. Use when you want bullish exposure but have a specific price target and want better entry terms.

FX risk reversals work the same way but are quoted differently - as the difference in volatility between puts and calls on a currency pair. They're closely watched indicators of currency sentiment. Conventions differ by currency pair (which currency's put is the reference).