A bearish risk reversal option strategy is built by selling an out-of-the-money call option and using the cash collected to buy an out-of-the-money put option on the same stock with the same expiration date. Traders implement this strategy when they hold a strong bearish view on a stock and want downside participation without spending significant capital upfront. The cash generated from selling the call reduces or completely eliminates the cost of buying the put.
Because you own a put option, your profit grows substantially as the stock price falls toward zero. However, because you sold an unhedged call option, your upside risk is unlimited. If the stock rallies sharply above the call strike price, you are obligated to deliver the underlying stock at that lower strike price, creating open-ended loss exposure on a rally.
- Sell $105 Call for $2.50
- Buy $95 Put for $2.50
- Stock ≤ $95: Substantial Profit Potential (e.g., +$1,000 at $85)
- Stock between $95 and $105: $0 Breakeven Zone
- Stock ≥ $105: Unlimited Loss Potential (e.g., -$1,000 at $115)