Option trading strategies definition
Another way to use legging is when the market changes direction or there are other unexpected circumstances which could affect the profitability of an existing position. It may be possible to exit one specific position, or enter into another, that changes your overall position and either increases your profits or reduces your losses. In this example, you have taken a long position by buying calls on a specific underlying security and combined that with a short position by selling cheaper out of the money calls on the same underlying security, with the expectation that the price of the underlying security will go up by a moderate amount.
The best situation with a bull call spread is that the underlying security does go up in value by an amount large enough to return a profit on the calls you have bought, but by a small enough amount that the calls you have written don't get into the money: If the underlying security actually goes up significantly in value, you will still make a profit on the calls you bought, but some of those profits would be offset by losses on the calls you wrote.
If you acted quickly enough once you realized the security was going up more than expected, you could exit your short position and buy back the calls you wrote at a small loss.
With the underlying security continuing to rise, you have made additional profits on the calls you bought, but you've only made a small loss on the short position so you increased your overall profitability. Equally, you could use legging to cut your losses on a trade. Again using the above example, if the underlying security actually fell in value, then you would profit from your short position with the calls you sold, but you would lose more on the long position with the calls you bought.
Had you seen this price fall coming, then you could have closed your long position and sold your calls at a loss before the price fell too much. This loss would then be covered either partially or wholly by the profit on the short position. As you can see, legging is a technique that has a number of uses and for the active trader it can represent a great way to not only potentially increase profits but also get out of bad trades and to generally be a more efficient trader.
The first thing that we should mention regarding legging is that it's really not a technique that is well suited for beginner options traders. Although the basic concept is pretty easy to understand, putting the technique to use is somewhat more complicated.
To successfully use it, you should be able to fully understand the implications of what you are doing, and also be able to recognize short term trends in the market. Ideally you should be able to make calculations and decisions quickly to determine exactly when the right time to leg into, or out of, any particular position is. When used correctly, it can turn unprofitable situations into profitable situations or increase the maximum profits of a situation overall.
The biggest risk, though, is that if you get it wrong you will either reduce the profits you might or even turn those profits into a loss. If you mistime the completion of legs, or carry them out in the wrong order, you can end up in a position where you have absolutely no chance of making any money. Legging definitely has strong advantages, but you simply must be aware of the risks involved and be absolutely sure you know what you are doing before attempting to use this technique.
Legging When Trading Options Legging is a technique that most options traders will probably want to use at some point. On this page we explain legging and its purpose for options trading in more detail, covering the following: Section Contents Quick Links. Legs and Legging Explained As explained above, the basic definition of a leg is that it's one component of any options trading strategy that requires making more than one transaction.
Reasons for Using Legging Legging is a very widely used technique in options trading, particularly by experienced investors and traders. There are a number of reasons why options traders may choose to leg into and out of positions, the following reasons are most common: A broker may not be able to carry out each transaction simultaneously It may not be profitable to carry out each transaction simultaneously It may be possible to make additional profits by legging into, or out of, a position Circumstances could change, and it may be necessary to alter the dynamics of an existing position through legging It may be prudent to leg out of a position to lock in profits or cut losses The advent of online brokers has greatly reduced the probability of the first reason being an issue.
Ordering Legs Correctly If you are using legging specifically to try and increase profits by taking a particular position, then getting the order of the legs rights is absolutely vital. An iron condor is typically a non-directional option spread where the trader sells an out of the In a married puts option strategy , the investor owns shares of stock and purchases an equal number In a Synthetic Call Option , the investor can create a pseudo call position by buying puts that The strike price exercise price is the level at which the buyer of a call option can exercise For in-the-money call options, intrinsic value is the difference between the stock price and the An option ask is the price an option seller wants to receive for the option.
If the option is Accelerated Time Decay refers to options that have less than a month to maturity decay at an A time premium is the amount by which the price of a stock option exceeds its intrinsic value. Each one is essentially a unique type of options spread, which involves combining multiple positions based on the same underlying security into one overall position. There are a number of reasons why these spreads are used and they are very powerful tools if you know how to use them correctly.
Ultimately, it's the ability to create these spreads that makes options trading such a versatile and potentially profitable form of investment. Although some of the strategies for trading options are quite straightforward and easy to understand, many of them are complicated and involve several different components.
While it isn'tt essential to have a working knowledge of each and every strategy that can be used, you are far more likely to be successful and make money consistently if you have a good idea of which ones to use and when. In this section, we provide detailed information on over fifty of the most commonly used options trading strategies and we also offer advice on how to choose a suitable one by taking relevant factors into account.
We should point out that this section has been compiled to help you learn all about the various options trading strategies that can be used and how to choose the right one depending on a number of factors. To get the most out of this section, you should already have a solid understanding on the subject of options trading, how the market works, and what is involved.
Please spend some time going through some of the earlier sections of this site if you feel you don't have the necessary knowledge. Remember, if you come across any words or phrases that you are unfamiliar with, you can refer to our comprehensive Glossary of Options Trading Terms for an explanation.
Choosing the right strategy at the right time isn't always an easy thing to do, because of the amount of different ones you have to choose from. However, which ones you choose and when will ultimately determine just how successful you are, so it's something that you really need to learn how to do. It's possible to make money through simply buying options with a view to selling them later at a profit, and indeed some investors do generate profits in this way.
The real money, though, is generally made by those that know how to employ different strategies and use the appropriate options spreads in any particular situation. Successful options trading isn't necessarily just a case of forecasting which way you think the price of an underlying security move and then trading the relevant options accordingly.