# Binary Options Risk Reversal

Home / Option Strategy Finder / Options Arbitrage

## Reversal

A reversal, or reverse conversion, is an arbitrage strategy in options trading that can be performed for a riskless profit when options are underpriced relative to the underlying stock. To do a reversal, the trader short sell the underlying stock and offset it with an equivalent synthetic long stock (long call + short put) position.

 Reversal Construction Short 100 Shares Sell 1 ATM Put Buy 1 ATM Call

## Limited Risk-free Profit

Profit is locked in immediately when the reversal is done and it can be calculated using the following formula:

Profit = Sale Price of Underlying - Strike Price of Call/Put + Put Premium - Call Premium

Reversal Payoff Diagram

## Example

Suppose XYZ stock is trading at \$100 in June and the JUL 100 call is priced at \$3 while the JUL 100 put is priced at \$4.

An arbitrage trader does a reversal by short selling 100 shares of XYZ for \$10000 while simultaneously buying a JUL 100 call for \$300 and selling a JUL 100 put for \$400. An initial credit of \$10100 is received when entering the trade.

If XYZ stock rallies to \$110 in July, the short JUL 100 put will expire worthless while the long JUL 100 call expires in the money and is exercised to cover the short stock position for \$10000.

Since the initial credit received was \$10100, the trader ends up with a net profit of \$100.

If instead XYZ stock had dropped to \$90 in July, the long JUL 100 call will expire worthless while the short JUL 100 put expires in the money and is assigned. The trader then buys back the obligated quantity of stock for \$10000 to cover his short stock position, again netting a profit of \$100.

Note: While we have covered the use of this strategy with reference to stock options, the reversal is equally applicable using ETF options, index options as well as options on futures.

## Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around \$10 to \$20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run.

If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only \$0.15 per contract (+\$4.95 per trade).

## Conversion

If the options are relatively overpriced, the conversion is used instead to perform the arbitrage trade.

### You May Also Like

Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

### Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

### What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

### Investing in Growth Stocks using LEAPSÂ® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®....

## Risk Reversal Binary Option Trading Strategy - anyoption

### Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

### Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement.

In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

### Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter.

You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

### Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading....

### What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator....

### Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969.

Ipo evaporator system cleaner

It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

### Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions.

They are known as "the greeks"....

Share trading platform with tax reporting