Risk Reversal Options Strategy: The Low-Cost Bullish Play Using Volatility Skew

Summary

A risk reversal buys an OTM call and sells an OTM put on the same stock with the same expiration. Because volatility skew makes puts more expensive than equidistant calls, the put premium often nearly or fully pays for the call, creating a bullish position at zero or near-zero cost. The tradeoff: you have unlimited upside but unlimited downside below the put strike. This is an aggressive bullish strategy best suited for traders with high conviction who understand the obligation of the short put.

Key Takeaways

The risk reversal exploits volatility skew by selling overpriced puts and buying underpriced calls. Net cost is typically $0 to $1.00 per share. Upside is unlimited above the call strike. Downside is equivalent to owning shares below the put strike. The strategy works best when you'd be happy to buy the stock at the put strike anyway (making the downside acceptable). It combines the benefits of a cash-secured put (income, discounted entry) with a speculative call (leveraged upside).

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Most options strategies require you to pay a premium. The risk reversal sidesteps this by using one option to fund the other. It's not free—you're accepting obligation for the possibility of profit—but the cash outlay at entry can be zero.

How It Works

Example: AAPL at $245, 30 DTE

  • Sell 1 $230 put for $3.00
  • Buy 1 $260 call for $2.50
  • Net credit: $0.50 ($50 received)

    • Scenario Analysis

    AAPL rises to $280: Call is worth $20.00, put expires worthless. Profit: $20.50 ($50 credit + $2,000 call value). You participated fully in the rally at zero cost.

    AAPL stays at $245: Both options expire worthless. Profit: $0.50 ($50 credit). You earned a small amount for having the position.

    AAPL drops to $230: Call expires worthless, put is at the money. You may be assigned 100 shares at $230 (effective cost $229.50 with the credit). This is a 6.3% discount to the current $245 price.

    AAPL drops to $210: Call expires worthless. You own shares at $229.50 with an unrealized loss of $1,950. This is the same risk as owning stock from $229.50.

    The Skew Advantage

    The risk reversal works because of volatility skew. In the example above:

  • The $230 put (15 points OTM) has higher IV than the $260 call (15 points OTM)
  • The put costs $3.00 because its IV is elevated
  • The call costs $2.50 because its IV is lower
  • You capture $0.50 of "skew premium"

    • Without skew, both options would cost the same and the position would be zero cost with no credit. Skew makes the strategy economically attractive because you're paid extra for the structural overpricing of puts.

    When to Use Risk Reversals

    As a Stock Replacement

    You want to own AAPL but not at $245. The risk reversal gives you:

  • A discounted entry at $230 if the stock pulls back (via the put)
  • Leveraged participation if the stock rallies above $260 (via the call)
  • A small credit in the meantime

    • This is strictly superior to a limit buy order at $230, which earns nothing while you wait.

    Before a Positive Catalyst

    You believe a stock will report strong earnings. Instead of paying $8.00 for an ATM call, you fund the call by selling a put. If earnings are strong, you capture the upside. If earnings are neutral, both options expire and you keep the credit. If earnings are bad, you own the stock at a discount.

    When Skew Is Unusually Steep

    When the 25-delta skew is above the 70th percentile, the risk reversal generates an above-average credit. The put is structurally overpriced relative to history, making this the ideal entry point for the strategy.

    Risk Reversal vs Related Strategies

    vs Collar

    A collar owns stock + buys a put + sells a call. The risk reversal is the same structure without the stock. The collar protects an existing position. The risk reversal creates a new position.

    vs Cash-Secured Put + Long Call

    A risk reversal is algebraically identical to selling a cash-secured put and using the premium to buy a call. The positions are the same; the risk reversal just combines them into a single concept.

    vs Buying Stock

    The risk reversal has better upside (leveraged through the call), similar downside (own stock below the put strike), but misses dividends and has an expiration deadline. For short-term bullish trades, the risk reversal is more capital efficient. For long-term holds, stock is simpler.

    Managing the Position

    Stock moves up quickly: If the call doubles or triples in value, consider closing for profit. The put will be nearly worthless and easy to close.

    Stock stays flat: Both options decay toward zero. Close the put for a profit (it's lost most of its value) and the call for a small loss or let both expire.

    Stock moves down toward the put strike: Decide whether you want to own shares at the strike. If yes, let it ride (you're getting shares at a discount). If no, close the put for a loss before assignment.

    Position Sizing

    Because the short put creates stock-like downside risk, size the risk reversal as if you're buying stock:

  • If you'd buy 100 shares of AAPL, one risk reversal is appropriate
  • Don't open 5 risk reversals thinking "they were free" because the downside on 5 puts is significant ($115,000 of stock exposure)

    • The "zero cost" entry is about cash outlay, not risk. The risk is real and should be sized accordingly.

    OptionsPilot's strike finder displays IV at each strike, making it easy to identify the optimal put and call strikes for a risk reversal and calculate the expected credit based on current skew levels.