Option Strategies Details

A trader who wants to speculate on a large increase in price and flat to increasing volatility can open a Risk Reversal. The trader may pay a small debit, receive a small credit, or even open the position for exactly $0.

Suppose stock XYZ is trading at $26. You forecast a large increase in XYZ price and an increase (or no decrease) in volatility.

You open a $24 / $28 Risk Reversal (selling the $24 Put and buying the $28 Call) for exactly $0.00, no cost, to express this view. How is this possible? The $24 Put bid price is $0.81 and the $28 Call ask price is $0.81, so when you sell the Put you receive a $0.81 credit, and you then use that $0.81 credit to buy the Call, netting out to $0.

This trade breaks even if XYZ price remains between $24 and $28, since the trade was entered for $0. Below $24, your PnL becomes negative quickly as the sold Put works against you and the bought Call approaches zero value. Above $28, your PnL becomes positive quickly as the bought Call gains value and the sold Put loses value. The time component of your trade plan may not extend all the way to expiration, so you should be prepared to close at a variety of XYZ prices as the market value of your $24 / $28 Risk Reversal changes. Because the price of XYZ can theoretically decrease down to $0, Risk Reversals carry a high "risk of ruin". However, a trader can reduce this risk by selling a Put Credit Spread, which has a defined max loss, rather than just selling a Put.