Risk Reversal

You take a position in a stock. You either buy it or go short. Then...you start to get scared. Suddenly, you're lying awake at night, running through scenarios about ways the trade could go wrong. You can't eat. You start randomly lashing out at people. Eventually, you lock yourself in a darkened office for long periods of time listening to Radiohead playlists.

Before you turn into a full depressive, maybe consider a risk reversal strategy. This structure, also known as a protective collar, is meant to hedge a position in an underlying asset. Basically, you use options to protect yourself against your main bet turning sour.

The process involves two options. You write one and you buy another. If your underlying position is long (like, you bought a stock) you would write a call option and buy a put. If your underlying position is short, you'd do the opposite: buy a call and write a put.

Say you're long. You write a call and buy a put. The put protects against the decline in the stock. If your underlying position goes south (if the stock starts to drop), you're covered by the put, which rises in value as shares fall below the put strike price. The call is meant to pay for the extra expense of the put. The put costs money to purchase. You receive money for writing the call. However, having the call limits your upside for the underlying position.

All told, the risk reversal protects your downside, but limits the upside...but at least you can sleep at night and eat regular meals.