The Risk-Reversal Premium

15 Pages Posted: 23 Nov 2021

See all articles by Blair Hull

Blair Hull

HTAA, LLC

Euan Sinclair

Bluefin Trading; FactorWave

Multiple version iconThere are 2 versions of this paper

Date Written: November 21, 2021

Abstract

We study the risk-reversal premium, where out-of-the-money puts are over-priced relative to out-of-the-money calls. This effect is driven by investors’ utility preferences which lead them to over-pay for the risk reduction benefits of long puts instead of valuing options on the basis of expected returns. Investors can exploit this implied skewness premium by trading standard, exchange-traded index options. We also show that including risk-reversals in an equity portfolio creates a better portfolio (as measured by Sharpe ratio) compared to a pure index position.

Keywords: Volatility, Skewness, Options, Diversification, Alternative Beta, Portfolio Management

JEL Classification: G00, G1, G11, G13

Suggested Citation

Hull, Blair and Sinclair, Euan and Sinclair, Euan, The Risk-Reversal Premium (November 21, 2021). Available at SSRN: https://ssrn.com/abstract=3968542 or http://dx.doi.org/10.2139/ssrn.3968542

Blair Hull

HTAA, LLC ( email )

141 W. Jackson Street #1650
Chicago, IL 60604
United States

Euan Sinclair (Contact Author)

Bluefin Trading ( email )

440 South LaSalle
Suite 900
Chicago, IL 60605
United States

FactorWave

CHICAGO, IL 60647
United States

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