Legging into spread trades and complex option strategies is a popular way for traders to get quicker fills. However, is this legging technique really the best approach or should we be doing things a little different when entering or exiting trades? In today’s show I’ll discuss my thoughts on approaching legging into and out of spreads and the benefits and risks of doing it or not as part of your trading system.
Key Points from Today's Show:
- Legging is when you take a trade and break it up into smaller components to get in or out of a position.
- A common way to leg into, for example, a credit spread is by buying the further out leg first and then selling the closer in leg later on.
- Instead of doing it as a combined order, you split the order up to do one at a time.
- Legging often comes into effect with more advanced orders such as iron butterflies and iron condors where you are trading three to four legs at a time.
Should You Use Legging As a Strategy Getting Into a Trade?
- For 90% of the time, you should not leg into a trade.
- Instead, place your orders as limit orders, stick with the position, and adjust the limit order as you go.
Example:
Getting into an iron condor, place the order for all four legs and wait to see if you get filled. If you are trading liquid options, your order is not going to move that much. Be firm in your order, and have patience. If the market does really move after your initial order, cancel that order and reset your strike price with the market.
When Using Legging is Appropriate.
- If you are getting into an iron condor or iron butterfly, you can break it down into logical components.
- “Logical components” means doing the call side of an iron condor completely, and then doing the put side completely.
Example:
Do a call credit spread, then let that fill or split the order into two orders and have them working at the same time. Then do the put side, a sell, and a buy at the same time. This does not mean that you do the strangle and then the outside legs. Do it risk-defined from the beginning. Do each side in its logical components; the credit spreads on one side and on the other side.
*Don't force the trade in just for the sake of making the trade.
Legging Out Of a Trade.
- When it comes to legging out of a trade, it is more appropriate to do this with context.
- Legging out of a position okay, as long as you are mainly closing out of the risky side of the trade.
- Make sure when leaving any options on, that they are not worth much money — if they do have value, close them out as well.
Example:
When you are doing an iron butterfly where you are selling at the money short strikes and buying far out wings to create a risk-defined straddle with protection, then it is okay to close out just the inside straddle and buy that back for a profit leaving the outside wings on to expire. This is technically considered legging out of the position. You are not closing the full thing, you are leaving the long wings on either end to expire worthless. You are just closing the inside legs that are at risk of being assigned.
*The same thing could be done for and iron condors as well.
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