A risk reversal combines a call and put with different strikes; in FX markets, the term also describes the implied-volatility difference between comparable calls and puts.
A risk reversal is an options combination that buys one type of option and sells the other on the same underlying asset and expiration date, usually at different out-of-the-money strikes. A long or bullish risk reversal buys a call and sells a put; the reverse position buys a put and sells a call.
The same term also has a second meaning in foreign-exchange markets: a risk-reversal quote is the difference between the implied volatilities of comparable out-of-the-money calls and puts. Readers should establish which meaning is intended before interpreting the number or strategy.
Assume both options use the same underlying and expiration.
| Structure | Long leg | Short leg | Directional exposure |
|---|---|---|---|
| Long or bullish risk reversal | Out-of-the-money call | Out-of-the-money put | Benefits from a sufficiently large price increase; exposed to losses below the put strike |
| Short or bearish risk reversal | Out-of-the-money put | Out-of-the-money call | Benefits from a sufficiently large price decline; exposed to losses above the call strike |
The premiums may be selected to produce a small debit, small credit, or roughly zero initial premium. “Zero cost” refers only to the net option premium at initiation. It does not remove spreads, commissions, margin, assignment, tax, or loss exposure.
Suppose a stock is at USD 100. A trader:
Ignoring transaction costs, the net initial premium is zero.
| Stock price at expiration | Simplified outcome per share |
|---|---|
| Above USD 105 | The call gains intrinsic value above USD 105 |
| Between USD 95 and USD 105 | Both options expire without intrinsic value |
| Below USD 95 | The short put loses value dollar for dollar below USD 95 |
At USD 80, the short put creates a USD 15 loss per share before costs. The position therefore has substantial downside exposure even though no net premium was paid in this simplified example.
A business or investor with an existing long exposure may buy a put and sell a call. The put creates downside protection below its strike, while the short call helps finance the put but limits gains above the call strike. When combined with the owned asset, this resembles a collar options strategy.
The options combination alone is still a risk reversal. The complete position, including the underlying exposure, determines whether it is a hedge or a directional trade.
In foreign-exchange options, market participants commonly compare the implied volatility of an out-of-the-money call with that of an out-of-the-money put having the same maturity and comparable delta.
A common convention is:
risk reversal = call implied volatility - put implied volatility
A positive value under that convention means the call has higher implied volatility than the comparable put. However, currency-pair and dealer quotation conventions can reverse the practical interpretation. Always verify:
The quote describes relative option pricing or skew. It is not a guaranteed forecast of the exchange rate.
| Strategy | Option legs | Main distinction |
|---|---|---|
| Risk reversal | Long call and short put, or long put and short call | Directional payoff with an obligation from the written option |
| Strangle | Long or short call and put | Both options are bought or both are sold |
| Bull spread | Calls or puts with different strikes | Usually caps both maximum gain and maximum loss |
| Collar | Long put and short call plus an owned underlying position | Defines a price floor and ceiling for the combined holding |
This article explains an options term and does not recommend a trade or hedge. Multi-leg options can involve substantial loss, assignment, leverage, margin, liquidity, and tax consequences. Review the current contract disclosure and obtain qualified advice where appropriate.