Risk Reversal

A risk reversal is the difference in implied volatility between two options on the same pair and the same expiry, one on each side of the current rate and at a matching distance from it. It is quoted as a single number with a sign, and it summarises which side of the market is being paid up for: protection against the pair rising, or protection against it falling. It is followed because it is one of the few visible measures of positioning in a market where positions are not published. A reading that leans one way says options on that side are bid relative to the other, which is usually described as demand for protection rather than as a directional forecast — the two are not the same thing, and a risk reversal can be at its most one-sided while the underlying rate has barely moved. The distance from the current rate used to define the pair of options is a quoting convention set by the market, so a reading is comparable only with readings taken on the same convention, and the publisher's own definition is the one that governs the number.