The Risk Reversal Options Strategy is a powerful directional options structure commonly used in FX, commodities, and equities to express a bullish or bearish view with reduced or zero net premium. It involves the simultaneous purchase of one out-of-the-money (OTM) option and the sale of another OTM option in the opposite direction, creating a synthetic position with defined risk characteristics and potential for leveraged profit.

This strategy is widely used by hedgers, macro traders, and institutional FX desks to manage currency risk, express conviction trades, or benefit from volatility skew in the options market.

What Is a Risk Reversal?

A Risk Reversal (RR) combines:

• Buying an OTM call and selling an OTM put = Bullish Risk Reversal
• Buying an OTM put and selling an OTM call = Bearish Risk Reversal

Both options typically share the same expiration date but have different strikes.

Payoff Profile:

• Unlimited potential gain above (or below) the long option strike
• Loss begins once price breaches the short option strike
• Often implemented for zero or low cost

Strategy Objective

• Express a strong directional view (up or down)
• Use skew to enter positions at reduced or no premium
• Hedge FX, equity, or commodity exposure while maintaining upside/downside potential
• Benefit from volatility asymmetry between puts and calls

Bullish Risk Reversal Example (EUR/USD)

• Spot price: 1.0800
• Buy 1-month EUR/USD 1.1000 Call
• Sell 1-month EUR/USD 1.0600 Put
• Net premium: Zero or small credit

Outcomes:

• Profit: If EUR/USD finishes above 1.1000
• Loss: If EUR/USD drops below 1.0600
• Breakeven: Effectively at the short put strike
• Max Loss: Unlimited below 1.0600 (unless hedged)

Use case: Bullish euro, but want free upside exposure and willing to accept downside risk

Bearish Risk Reversal Example (USD/JPY)

• Spot price: 145.00
• Buy 1-month USD/JPY 140.00 Put
• Sell 1-month USD/JPY 150.00 Call
• Net premium: Low or zero

Outcomes:

• Profit: Below 140.00
• Loss: Above 150.00
• Ideal for bearish view on USD/JPY with tight budget or yield-seeking structure

Hedging Application

Corporates use risk reversals to hedge currency exposure with minimal premium cost:

• An importer expecting dollar strength can buy USD call and sell USD put
• An exporter expecting euro weakness can buy EUR put and sell EUR call
• Both reduce hedging costs and gain favourable exposure within a range

Why Use Risk Reversals?

• Zero-premium directional exposure
• Capture volatility skew, especially in FX where puts and calls are priced asymmetrically
• Build hedges that don’t require upfront cash
• Gain leverage without buying outright options
• Customisable strikes to suit your risk tolerance and price targets

Volatility Skew & Market Sentiment

• In FX, the difference in IV between OTM calls and puts reflects sentiment
  • Put > Call IV: Market hedging against downside (bearish bias)
  • Call > Put IV: Bullish sentiment or upside protection demand
• Traders use this skew to structure risk reversals in line with market fear/optimism

Risk Management Considerations

• Unlimited downside risk if underlying moves far past short leg
• May require margin for the short option
• Ideal for experienced traders with strong conviction and hedging skills
• Losses can exceed gains if market moves sharply in the wrong direction

Advantages of the Risk Reversal

• Low or zero cost implementation
• Tailored directional strategy with defined strikes
• Flexible for hedging or speculative use
• Skew-sensitive: takes advantage of market fear or complacency

Drawbacks

• Asymmetrical risk: limited reward, but potentially large losses
• Requires active management in volatile conditions
• Not suitable for low-conviction or range-bound views
• Limited liquidity in exotic pairs or long-dated contracts

Conclusion

The Risk Reversal Options Strategy is an essential tool in a professional trader’s playbook, enabling conviction-driven exposure with minimal cost and full customisation. Whether used for hedging or speculation, it offers a capital-efficient way to trade FX, commodities, or equities with a directional edge shaped by market sentiment and volatility dynamics.

To learn how to structure, hedge, and manage risk reversal strategies effectively using professional frameworks and real-time macro tools, enrol in our expert-level Trading Courses and trade with institutional-grade precision.