Risk Reversal

What is a 'Risk Reversal'

A risk reversal, in commodities trading, 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.

BREAKING DOWN '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. Call On A Put

    One of the four types of compound options, this is a call option ...
  2. Strangle

    An options strategy where the investor holds a position in both ...
  3. Compound Option

    An option for which the underlying is another option. Therefore, ...
  4. Put On A Call

    One of the four types of compound options, this is a "put" option ...
  5. Strap

    An options strategy created by being long in one put and two ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
Related Articles
  1. Trading

    A Guide Of Option Trading Strategies For Beginners

    Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
  2. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  3. Trading

    How To Profit From Volatility

    We explain four key strategies to profit fom volatility in markets.
  4. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
  5. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  6. Trading

    The Anatomy of Options

    Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio.
  7. Trading

    How To Profit From Oil Volatility With The Following Strategies

    The recent volatility in oil prices presents an excellent opportunity for traders to make a profit if they are able to predict the right direction.
  8. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  9. Investing

    What is Meant by Implied Volatility?

    The estimated volatility of a security's price.
  10. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
RELATED FAQS
  1. How does implied volatility impact the pricing of options?

    Learn about two specific volatility types associated with options and how implied volatility can impact the pricing of options. Read Answer >>
  2. Are put options more difficult to trade than call options?

    Learn about the difficulty of trading both call and put options. Explore how put options earn profits with underlying assets ... Read Answer >>
  3. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
  4. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
  5. Do options make more sense during bull or bear markets?

    Understand how options may be used in both bullish and bearish markets, and learn the basics of options pricing and certain ... Read Answer >>
  6. What's an effective options strategies for investing in the food and beverage sector?

    Discover two options strategies that are well-suited for investors in the food and beverage sector that can be used to increase ... Read Answer >>
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center