Risk Reversal

Core Thesis

A Bullish Risk Reversal (short put + long call) creates stock-like upside with reduced upfront cash outlay. It is a high-conviction directional structure that transfers downside tail risk to fund upside optionality.

Structure

• Short put at $K_p$.
• Long call at $K_c$.
• Same expiration; net entry cost can be credit, debit, or near zero.

Expiration Payoff Mathematics

Let net premium at entry be $N$ (credit positive):

$$\Pi_T = \max(S_T-K_c,0) - \max(K_p-S_T,0) + N$$

• Upside: unlimited beyond $K_c$.
• Downside risk: substantial below $K_p$ (similar to owning stock through that region).
• Downside break-even near $K_p - N$.

Greek and Skew Exposure

• High positive delta at entry.
• Short downside skew via short put; crash regimes can reprice put wing aggressively.
• Vega effect is skew-dependent rather than purely parallel IV shift.

Design Rules

• Use when conviction is strongly bullish and willingness to own downside exists.
• Strike spacing defines no-man's land where PnL is flatter between $K_p$ and $K_c$.
• Assess borrow/dividend/rates context if benchmarking versus synthetic forwards.

Management Framework

• If thesis fails, reduce short-put risk promptly.
• Roll call only when maintaining convex upside is still justified.
• Treat as directional core with explicit tail-risk budget.

Failure Modes

• Underestimating left-tail damage from short put in macro shocks.
• Entering near event risk without skew compensation.
• Using it as "cheap upside" without balance-sheet capacity for assignment.

Practical Checklist

• Is downside obligation at $K_p$ acceptable under stress scenarios?
• Does net premium structure justify skew risk transferred?
• Is this superior to long stock or bull call spread for the same thesis?