The investment universe consists of SPY options with maturity as close to 25 days as possible. At the start, buy 15-delta calls and sell 15-delta puts with said maturity, and short 30 shares of SPY to initiate the position.
ASSET CLASS: options | REGION: United States | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Risk-Reversal, Options, Strategy
I. STRATEGY IN A NUTSHELL
The strategy trades SPY options with ~25-day maturity by buying 15-delta calls, selling 15-delta puts, and shorting 30 SPY shares. Positions are rebalanced when net delta falls below 20 or rises above 40, and closed five days before expiration.
II. ECONOMIC RATIONALE
Risk-reversal mispricing occurs because OTM puts are overvalued relative to calls, driven by high downward-hedging demand and limited selling. Selling OTM puts captures this premium, amplified by the positive correlation between volatility and the underlying price.
III. SOURCE PAPER
The Risk-Reversal Premium [Click to Open PDF]
Blair Hull, HTAA, LLC; Euan Sinclair, Bluefin Trading; [Next Author], FactorWave
<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.
IV. BACKTEST PERFORMANCE
| Annualised Return | 8.9% |
| Volatility | 11.1% |
| Beta | N/A |
| Sharpe Ratio | 1 |
| Sortino Ratio | N/A |
| Maximum Drawdown | 24.6% |
| Win Rate | 71% |
