Risk Reversal Investment Strategy
A risk-reversal consists of being short (selling) an out of the money put and being long (i.e. buying) an out of the money call, both with the same maturity.
A risk reversal is a position in which you simulate the behavior of a long; therefore it is sometimes called a synthetic long. This is an investment strategy that amounts to both buying and selling out-of-money options simultaneously. In this strategy, the investor will first make a market hunch; if that hunch is bullish he will want to go long. However, instead of going long on the stock, he will buy an out of the money call option, and simultaneously sell an out of the money put option. Presumably he will use the money from the sale of the put option to purchase the call option. Then as the stock goes up in price, the call option will be worth more, and the put option will be worth less.
If an investor holds the underlying (stock or FX) and sells a risk reversal, then he has a collar position. i.e.
- Underlying - Risk_Reversal = collar
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