Risk reversal

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A risk reversal is an options strategy, or conversion that consists of buying an out-of-the-money call and selling an out-of-the-money put. This is done versus a short position in the underlying instrument.[1]

It is a generic strategy that can be applied to many different trading instruments with options traded on them. The option position is essentially a synthetic futures contract against a short underlying position.[2]

Reasons for using a risk reversal strategy include taking advantage of skew, fine tuning risk reward and shifting time frames.[3]

The CBOE has a contract called "CBOE S&P 500 Risk Reversal Index (RXM)" that "is a benchmark index designed to track the performance of a hypothetical risk reversal strategy that: (1) buys a rolling out-of-the-money (delta ≈ 0.25) monthly SPX Call option; (2) sells a rolling out-of-the-money (delta ≈ - 0.25) monthly SPX Put option; and (3) holds a rolling money market account invested in one-month Treasury bills to cover the liability from the short SPX Put option position."[4]

References

  1. Reversal. The Options Guide.
  2. Synthetic Long Stock. Options Industry Council.
  3. Why implement a risk reversal strategy with options? Simply in order to have more room for noisy movements in the underlying?. Quora.com.
  4. CBOE S&P 500 Risk Reversal Index (RXM). CBOE.