What does a Risk Reversal strategy involve?

A Risk Reversal strategy involves taking a long position in an out-of-the-money call option while simultaneously shorting an out-of-the-money put option. This strategy is often used to express a bullish sentiment on the underlying asset, allowing the investor to benefit from upward price movements.

By purchasing an out-of-the-money call, the investor has the right to buy the underlying asset at a specified strike price, which is advantageous if the asset's price rises above that level. Shorting the out-of-the-money put option generates income through the premium received, which can help offset the cost of purchasing the call option. This combination effectively provides a leveraged play on the asset while managing the downside risk to some extent.

This strategy is particularly popular in volatile markets where investors anticipate upward price movement and want to limit their exposure to downside risk. Therefore, the correct understanding of a Risk Reversal strategy as a long call and short put aligns well with its purpose in options trading.