Risk Reversal: how the position works

Sell an out-of-the-money put and use the proceeds to buy an out-of-the-money call. The result is a synthetic long position with a gap in the middle: nothing happens between the strikes, and outside them it behaves much like owning the underlying. It is cheap or free to enter, and that is exactly why it deserves care — the financing comes from selling the downside.

Market view: Bullish — leveraged, undefined risk
Opened for: Debit or credit
Maximum profit: Unlimited above the call strike.
Maximum loss: K_p − net credit, approached as the underlying falls to zero. Substantial.
Breakeven: K_c − net credit if opened for a credit, or K_c + net debit if opened for a debit.

How it is built

Sell 1 out-of-the-money put at K_p
Buy 1 out-of-the-money call at K_c, K_c > K_p, same expiry

All figures above are quoted per share and settle at expiry. A standard equity option covers 100 shares, so multiply by 100 for a single contract.

Before expiry: the Greeks

Strongly long delta with a flat middle, and it is the vega that gives the structure its name: it is long the call's volatility and short the put's, so on an underlying with the usual equity skew it is short volatility on balance. In currency markets the price of this structure is quoted directly as the risk reversal and is the standard measure of skew.

When to use it

When you are firmly bullish, want leverage without paying net premium, and are genuinely prepared to own the underlying at the put strike. It is also the natural way to monetise steep put skew, since you are selling the expensive wing to buy the cheaper one.

What goes wrong

The downside is large and only bounded by zero. This is not a defined-risk position and should not be sized like one.
Margin requirements on the naked short put are substantial and rise as the market falls, which is when the position is already losing.
A zero-cost entry disguises the risk. Costing nothing to open says nothing about what it can cost to hold.

A worked example

SPY at 580, 45 days out. Sell the 550 put for 6.30, buy the 610 call for 6.10.

Net credit received: $0.20 per share — $20
Upside participation begins: $610
Downside exposure begins: $550
Result between 550 and 610: +$20, the credit, and nothing else
Loss if SPY falls to 500: $4,980 ((550 − 500) × 100 − 20)

Commissions, exchange fees, financing and the bid/ask spread are excluded. On a multi-leg position the spread is usually the largest of these. The short put requires margin well above the $20 credit received.

Common questions

How does this differ from just buying the stock?

Between the strikes it does nothing, so it needs a real move to pay. Outside them it behaves similarly but with far less capital committed, which means the leverage — and the margin call risk — is much higher.

Related strategies

Educational only. This page explains how a structure behaves; it is not a recommendation to trade it. Options and futures carry substantial risk, and short and leveraged positions can lose more than the amount originally invested.