Risk Reversal

The name comes from the fact that you're 'reversing' your risk profile from one side to another. In a bullish risk reversal, you're taking on downside risk (short put) in exchange for upside potential (long call). You're literally reversing where your risk lies.

Buying a call costs money (debit) with defined risk. A risk reversal often costs nothing but has substantial downside risk from the short put. You're financing the call by taking on put risk. The tradeoff is lower cost but higher risk.

Yes! Unlike buying a call where you can only lose the premium, a risk reversal has substantial downside from the short put. If the stock crashes, you could lose the put strike value minus any credit received. This is the key risk.

You'll be obligated to buy 100 shares at the put strike price. For a $30 put, you'd need $3,000 (or margin equivalent) to buy the shares. You can then hold them (you're bullish anyway), sell them, or sell calls against them.

It depends. Risk reversal offers leveraged exposure at low cost but has defined risk/reward zones. Stock has linear P&L. RR outperforms above the call strike but can lose more below the put strike. Neither is universally better.

If stock stays between strikes, both options may expire worthless. You keep any initial credit or lose any initial debit. Consider closing early if theta decay is eating into position value, or roll to extend time.

Consider rolling when: 1) Stock approaches put strike, 2) Put delta exceeds 40-50, 3) You want more time. Roll to a lower strike and/or later expiration. This reduces assignment risk but may cost a debit.

Earnings create binary risk. IV typically spikes before and crashes after. If you're holding through earnings, the IV crush will affect both options. The short put benefits from IV crush; long call is hurt. Consider closing before earnings.

Yes! If assigned on the put, you own stock + long call = synthetic covered call. You can sell another call for a covered strangle. If you buy the stock, you have a collar. Risk reversals are versatile building blocks.

Skew determines whether you pay or receive premium. High skew means puts are expensive (good for selling). Since you're selling puts and buying calls, high skew benefits bullish RRs. Monitor skew before and during trades.

To be skew-neutral, adjust strikes so the trade is purely directional. Use delta-equivalent strikes and monitor skew changes separately. Alternatively, pair a bullish RR with a bearish RR on correlated assets to isolate skew exposure.

25-delta is standard, balancing premium and probability. For more leverage, use 30-40 delta (closer strikes). For more cushion, use 15-20 delta (wider strikes). Adjust based on conviction and risk tolerance.

Use SPY/QQQ risk reversals scaled to portfolio beta. Bullish RR adds upside participation beyond current holdings. Bearish RR creates portfolio protection (like a collar). Size based on delta exposure you want to add/hedge.

European options (SPX) can't be early assigned, eliminating assignment risk on short puts until expiration. This simplifies management but changes at-expiration behavior. Cash settlement means no stock delivery.

Indirectly. If assigned on a short put before ex-dividend, you'll receive the dividend on the shares. However, this isn't a reliable dividend capture strategy. Early assignment is more likely near ex-dividend on ITM puts.