Risk Reversal Strategy

You sell a $50 put and buy a $55 call on Stock XYZ, both expiring in one month, and collect a net premium of $1. What are the breakeven points, and what are your profits if the stock ends at $60 or $45?

Answer

First of all, this strategy is called risk reversal strategy.

  • Downside breakeven: At spot \(S_T = 50 - 1 = \$49\). There is no other breakeven point due to the floor being \(\>0\).

  • If \(S_T = \$60\): Call pays \(60-55=5\), put expires worthless, plus $1 premium → profit = $6.

  • If \(S_T = \$45\): Put loss \(=45-50=-5\), call expires worthless, plus $1 premium → profit = \(-\$4\).

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