(While on vacation until Oct 26th, I’m going to be sharing some anecdotes on my favorite trading strategies: why I use them, when, and how I manage them once they are on.)
Ok, so perhaps there’s some recency bias here as the most recent bullish Risk Reversals I’ve put on have worked. Really though, all that has done is remind me that I should probably do more of these trades.
In a nutshell, a bullish Risk Reversal is a trade where we short naked puts and use those proceeds to pay for long calls. That’s right, the market pays me to get long!
The trade is put on for a small net credit (ideally), and the short term goal is to ride an increase in the value of the calls which will allow us to sell a portion of them and use those proceeds to buy-to-close all the naked short puts. This then leaves us long the remaining portion of our calls for free! The calls could eventually reverse on us and go to zero, but we’ll still keep the credit we received when we originally put the trade on (plus whatever credit we may have gained when we sold some calls to close all the puts). This is a great situation to be in! [Read more…]