Risk Reversal

AAA

DEFINITION of 'Risk Reversal'

1. In commodities trading, it is a hedge strategy that consists of selling a call and buying a put option. This strategy protects against unfavorable, downward price movements but limits the profits that can be made from favorable upward price movements.

2. In foreign-exchange trading, risk reversal is the difference in volatility (delta) between similar call and put options, which conveys market information used to make trading decisions.

INVESTOPEDIA EXPLAINS 'Risk Reversal'

1. For example, say Producer ABC purchased an $11 June put option and sold a $13.50 June call option at even money (put and call premiums are equal). Under this scenario, the producer is protected against any price moves in June below $11 but the benefit of upward price movements reaches the maximum limit at $13.50.

2. Risk reversal refers to the manner in which similar out-of-the-money call and put options, usually FX options, are quoted by dealers. Instead of quoting these options' prices, dealers quote their volatility. The greater the demand for an options contract, the greater its volatility and its price. A positive risk reversal means the volatility of calls is greater than the volatility of similar puts, which implies that more market participants are betting on a rise in the currency than on a drop, and vice versa if the risk reversal is negative. Thus, risk reversals can be used to gauge positions in the FX market and can convey information to make trading decisions.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Foreign-Exchange Risk

    1. The risk of an investment's value changing due to changes ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
  4. Commodity

    1. A basic good used in commerce that is interchangeable with ...
  5. Forex - FX

    The market in which currencies are traded. The forex market is ...
  6. In The Money

    1. For a call option, when the option's strike price is below ...
Related Articles
  1. Options & Futures

    Capturing Profits With Position-Delta Neutral Trading

    This trading strategy will show you how to gain from a decline in implied volatility on any movement of the underlying.
  2. Options & Futures

    Options Trading Strategies: Understanding Position Delta

    Learn more about the position delta hedge ratio and how it can tell you the number of contracts needed to hedge a position in the underlying asset.
  3. Options & Futures

    Options On Futures: A World Of Potential Profit

    There's one simple hurdle in the transition from stock to futures options: learning about product specifications.
  4. Options & Futures

    An Option Strategy for Trading Market Bottoms

    The reverse calendar spreads offers a low-risk trading setup that has profit potential in both directions.
  5. Options & Futures

    Gauging Major Turns With Psychology

    Knowing what the market is thinking is the best way to determine what it will do next.
  6. Options & Futures

    What are the most common momentum oscillators used in options trading?

    Read about some of the most common technical momentum oscillators that options traders use, and learn why momentum is a critical concept for options trading.
  7. Options & Futures

    How are Bollinger Bands® used in options trading?

    Use Bollinger Bands to identify volatility changes and place options trades at the right time; profit in bull or bear markets using these strategies.
  8. Options & Futures

    Stock Futures vs Stock Options

    A full analysis of when is it better to trade stock futures vs when is it better to trade options on a particular stock. A quick overview of how each of them works and why would a trader, investor, ...
  9. Options & Futures

    The Potential Of Low-Priced Options

    The benefits of trading low-priced options, and learning how to pinpoint them, can be a very profitable strategy for an options trader.
  10. Options & Futures

    Who created Bollinger Bands®?

    Learn about John Bollinger and his widely followed indicator, Bollinger Bands. Explore how traders interpret the different signals it provides.

You May Also Like

Hot Definitions
  1. Santa Claus Rally

    A surge in the price of stocks that often occurs in the week between Christmas and New Year's Day. There are numerous explanations ...
  2. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  3. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  4. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  5. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  6. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
Trading Center