Leg (Options)

Definition

The term leg refers to one component of an options trading strategy that is constructed using two or more components.  A trader may combine multiple derivative contracts, or legs, in order to profit from spreads or hedge a position.

Explanation

When a trader executes a strategy involving two or more options, or derivative contracts, each of those positions is referred to as a leg.  There are a variety of reasons an investor might use multiple legs, including:  hedging, taking advantage of a spread, to lock in a profitable position, or even benefit from a temporary pricing arbitrage opportunity.  An investor might use a multiple leg strategy that involves offsetting positions, or simply use a second leg to collect a premium to offset the cost of the primary leg of the position.

Examples of multiple leg options include:

  • Box Spread: a four-sided option involving a long call and a short put at one strike price in addition to a short call and a long put at a different strike price. The strategy involves minimal risk but may allow the investor to assume an arbitrage position that provides a very small return upon expiration of the contracts.
  • Bear Call Spread:  a strategy involving both a short call option as well as a long call option.  The strategy is used when an investor would like to profit from a stock that declines or remains steady in price.
  • Bear Put Spread: a strategy involving the purchase of one put and the sale of a second put with a higher strike price (long put), which is used to help offset the cost of purchasing the lower strike priced put (short put).
  • Bull Call Spread:  a strategy involving both a short call option as well as a long call option.  The strategy is used when an investor would like to profit from a stock that increases in price, without the risk of an upfront capital investment.
  • Bull Put Spread: a strategy involving the sale of one put (short put) and the purchase of a second put with a lower strike price (long put), which is used to help offset the cost of purchasing the higher strike priced put (short put).  The strategy is used when an investor would like to profit from a stock that increases in value.
  • Calendar Spread: constructed using call or put options with identical strike prices, but different expiration dates.  The outlook for the stock should be directionally neutral since the approach leverages the concept of time decay.
  • Backspread: a strategy involving both long and short position options.  The premium received for selling the short option is used to help finance the purchase of the long options.
  • Condor Spread: a limited-risk, limited-profit, non-directional options strategy.  Executing a condor involves the purchase of four calls, each with a different strike price, but having the same expiration date and underlying security.
  • Diagonal Spread: a strategy whereby the investor assumes both a long and short position in options of the same type (calls or puts).  Each option has the same underlying security, but different strike prices and expiration dates.

Related Terms

liquid market, support, resistance, breakout, pin risk