Equity Risk Reversal

Payoff Pattern of an Equity Risk Reversal
A contract or pair of contracts which in combination provide a payoff pattern in an equity instrument similar to the interest rate collar or range forward contract in fixed income and currency markets respectively. The term 'risk reversal' is also used to describe the comparable interest rate and currency market positions. In the most common structure, the investor buys a put which provides downside protection and pays for the put with the sale of a call, which caps upside return. Although there is no necessary connection between the premium paid for the put and the premium received for the call, most users elect a zero premium risk reversal rather than pay or receive a net premium. Some users fail to appreciate that they may be called upon to make payments on the short option. These payments may be covered by failure to participate in the price movement of the underlying in some structures. Also called Min Max, Zero Cost Hedge, Collar (2) (diagram), Fence or Fence Spread, Cylinder (1), Knock-In Risk Reversal (diagrams), Risk Reversal, Spread Conversion, Conversion Spread, Forward Rate Bracket, Range Forward Contract (diagram), Tunnel Option, Hedge Wrap, Cap and Floor. See also Choke, Interest Rate Collar (diagram), Free Collar, Zero Cost Collar, Zero Cost Option.

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