Risk reversal

Summary

A risk reversal sells a put below the price and uses the cash to buy a call above it, for when you want the rise of 100 shares for little money and accept a fall like owning them. In the XYZ example it costs $44: above $105 every dollar of rise makes $100 with no limit, between $94 and $105 you lose just the $44, and you break even at $105.44. Below $94 every dollar of fall costs $100, and a fall to zero would lose $9,444.

Key terms

risk reversal

A sold put below the price paired with a bought call above it, which gains like shares above the call and loses like shares below the put.

long combo

Another name for the risk reversal: sell an out-of-the-money put and buy an out-of-the-money call.

sold put

bought call

skew

The tilt of implied volatility across strikes, one volatility for each strike, usually rising toward the far puts.

net debit

When a pair of trades sends cash out overall.

break-even

The stock price on the last day where you neither make nor lose money: strike plus premium for a call, strike minus premium for a put.

T plus zero line

The blue line on the chart showing your result today, if you closed the trade right now.

time value

The rest of an option's price, paid for the chance things get better before the end, and gone by the last day.

margin

Money your broker holds against what a sold position could lose.