Monday, June 27, 2011

Options 101: The Risk Reversal

A risk reversal consists of buying an out of the money call and being short an out of the money put, both with the same expiration month.

Risk reversals are used when the investor has a market opinion. For example, if the trader is bullish, another option besides going long the stock, would be to buy an out of the money call option, and simultaneously sell an out of the money put option. The money he receives from the sale of the put option would finance all or part of the purchase of the call options. Then as the stock goes up in price, the call option will increase in value, and the put option will decrease in value.

The graph above is an example of the Ford September $11/$15 bull call spread. In this spread, the trader sold the $11 put at $0.17 and bought the $15 call at $0.28 for a debit of $0.11. The trader's risk is being put the stock at the strike price of the short put. The profit potential is unlimited to the upside.

*Special thanks to Option Radar, BMO Capital, MEB Options, LiveVolPro, CBOE, Option Monster, T.O.P. group, and all of the options desks and traders we work with to provide the option flow!

No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

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