A hedge strategy that involves selling a call and purchasing a put to protect investors in commodity markets against unfavorable, downside price movements. However, it limits upward potential in price movements. For example, a wheat producer may purchase a $10 July put and sell a $13 July call for equal premiums so he is protected against unfavorable wheat price movements below $10. Notwithstanding, the wheat producer will be stuck to a maximum price of $13 in case future wheat trades through $13.

Risk reversal could also refer to the volatility differential between same-features currency calls and puts, where dealers quote these options’ volatilities rather than their prices. Option volatility, and therefore its price, are a function to demand. The larger the demand for an option, the greater its volatility and price. Thus, a positive risk reversal implies that volatility of calls are more than that of otherwise identical puts. This means the market at large is expecting the underlying currency to appreciate. On the contrary, negative risk reversal indicates the opposite: that volatility of puts are greater than volatility of calls, implying that investors are betting on a depreciation in the underlying currency.