What Is Leg Out?
Leg out refers to one side of a complex (i.e., multi-leg) options transaction. A leg is a piece of an options strategy known as spreading or a combo, where traders simultaneously buy and sell options on the same underlying security, but with different strike prices or different expiration months. This may involve either call and put options. Rather than closing out an entire spread position, a trader can leg out of just part of the spread, leaving the rest in place. Legging out, in this sense, is the opposite of legging-in, or putting on a new spread strategy one leg at a time.
Leg out can thus mean to close out, or unwind, one leg at a time of an existing derivative position. This effectively removes any additional possibility of loss or gain from that leg of the position. But, if the original spread transaction consisted of multiple legs, legging out of a transaction leg can still leave the investor with exposure to the other legs.
Colloquially, leaving a "leg out" may also refer to leaving one's choices open to provide some flexibility in case an opportunity arises.
- Leg out refers to the act of exiting one-at-a-time from multiple individual positions that combine to form a complex options strategy such as a spread.
- Legging out of a complex strategy can be advantageous to a trader, if taking off the position one piece at a time will prove to be less expensive than exiting it all at once.
- There is leg risk associated with this strategy, which is the risk that the market price in one or more of the desired legs will become unfavorable during the time it takes to complete the various individual orders.
Understanding Leg Out
Legging in and out can be done with several different types of options positions. Investors can leg out of any existing spread or combination, such as strips, straps, calendar spreads, straddles, and strangles, among many other complex positions. Legging out is done when the investor is ready to close part of the position. A leg simply refers to one part of the transaction, such as a straddle which has two legs made up of two options—buying or selling both a call and a put at the same expiration and strike price.
Traders may opt to leg in or leg out of options positions when they believe it to be easier or more cost-effective to trade it one leg at a time, rather than make a bid or offer for the spread/combo as a single package deal.
To trade a spread, the trader must find an eager counterparty who wishes to take the exact opposite position for a fair price and for enough size. Often, especially with complex strategies, this eager counterparty either doesn't exist or is difficult to find. Therefore, the trader will be better off doing it one leg at a time.
Example of Legging Out
Say, as an example, that a trader wishes to put on an XYZ 1x2 ratio put spread using the 40 and 35 strike puts. After checking with her colleagues and after using a broker to quote the spread as a single unit, she determines that she can buy the 40 put on a floor exchange and sell two of the 35 puts on an electronic exchange's screens. She has effectively legged into the trade.
A month goes by and the 35 strike puts have lost much of their value, and the trader decides to close out of these small puts by buying them back on the screens for a nickel. She has thus legged out of that part of the spread.