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