Long Leg What It Means How It Works Example

Long Leg What It Means How It Works Example

Long Leg: Meaning, How It Works, Example

What Is Long Leg?

A long leg is the long part of a spread or combination strategy that involves taking two or more simultaneous positions. It contrasts with a short leg, which is any contract in an options spread or combination where an individual holds a short position.

Key Takeaways

  • A long leg refers to positions purchased in a multi-leg derivatives strategy.
  • In an options spread, a long leg is paired with one or more short legs.
  • The long leg of a spread requires the outlay of premium to purchase contracts, which may be offset by sales from the short legs.

Understanding Long Leg

If a trader creates an options spread or combination by purchasing a call option and selling a put option, the trader’s position on the call is the long leg, while the put option is the short leg. Multi-legged spreading and combination strategies can have more than one short leg.

Long legs are found in a wide range of spread and combination scenarios. Generally, a long leg position is entered with a simultaneous short leg position. The combination of the two positions is referred to as a unit trade or spread investment.

Multi-leg options orders are more advanced than buying a put or a call on a stock in a directional bet.

A common multi-leg options order is a straddle where a trader buys both a put and a call at or near the current price, each having the same strike price. The straddle has two long legs: the long call option and the long put option. This multi-leg order simply needs the underlying asset to see enough price movement to create a profit—the direction of that price movement is irrelevant as long as the magnitude is there.

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A variation on the straddle is a strangle, which involves two long legs, a call and a put, but with different strike prices. Depending on the trading platform, investors can state their trading idea and a multi-leg order will be suggested to capitalize on that idea.

Long Legs in Option Spreads

Options spreads and combinations are positions created by options traders simultaneously buying and selling options contracts, with differing strikes or different expirations, but on the same underlying security. Options spreads are used to limit overall risk or customize payoff structures by ensuring that gains and losses are restricted to a specific range. Additionally, options spreads can bring the costs of options positions down, since traders collect premiums from contracts they short.

Options spreads can be made in all sorts of configurations, although certain standard spreads such as vertical spreads and butterflies are commonly used.

Each spread is composed of short and long legs of the trade. If the aggregate premium collected from the short legs exceeds that of the long legs, the spread is sold and the trader collects the net premium. On the other hand, if the premium collected from the short legs is less than the premium paid for the long legs, the trader is buying the spread and must pay the net premium.

Long Leg Example

For example, consider a bull call spread on a stock trading at $25.00 per share. This spread involves buying a call option at a strike price of $26 and simultaneously selling a call option at a higher strike price of $27. Both options have the same expiration date. In this case, the $26 call constitutes the long leg of the spread, while the $27 call makes up the short leg.

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Spreads involving two or more positions generally have lower risk but limited reward compared to single options positions or owning the underlying asset outright. Profit or loss from spread trades is generally followed through payoff diagrams that chart payoffs based on movements of the underlying asset.

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