What is a 'Leg'

A leg is a one component of a derivatives trading strategy, in which a trader combines multiple options contracts or multiple futures contracts (or rarely, combinations of both) in an attempt to hedge a position, benefit from arbitrage, or profit from a spread. Within these strategies, each derivative contract or position in the underlying security is called a leg. The cash flows exchanged in a swap are also referred to as legs.

BREAKING DOWN 'Leg'

Options

Options are derivative contracts that give traders the right, but not the obligation to buy (a call option) or sell (a put option) the underlying security for an agreed-upon price (the strike price) on or before a certain expiration date (in the case of American options). The simplest option strategies are single-legged, involving one contract. These come in four basic forms:

Bullish Bearish
Long call (buy a call option) Short call (sell or "write" a call option)
Short put (sell or "write" a put option) Long put (buy a put option)

A fifth, the cash-secured put, involves selling a put option and keeping the cash on hand to buy the underlying security if option is exercised.

By combining these options with each other, and/or with short or long positions in the underlying securities, traders can construct complex bets on future price movements, leverage their potential gains, limit their potential losses—even make free money through arbitrage, the practice of capitalizing on rare market inefficiencies. Below are examples of two-, three- and four-leg options strategies:

Two-Leg Strategy: Long Straddle

The long straddle is an example of an options strategy composed of two legs, a long call and a long put. As the chart below shows, the combination of these two contracts yields a profit if the underlying security's price rises or falls. The investor breaks even if the price goes up by her net debit (the price she paid for the two contracts, plus commission fees) or if it decreases by her net debit; if it moves further in either direction, she profits. Otherwise she loses money, but her loss is limited to her net debit.

Three-Leg Strategy: Collar

The collar comprises three legs: a long position in the underlying security, a long put and a short call. This combination amounts to a bet that the underlying price will go up, but it's hedged by the long put, which limits the potential for loss; this combination alone is known as a protective put. By adding a short call, the investor has limited his potential profit. On the other hand, the money he received from selling the call offset the price of the put, and might even have exceeded it, lowering his net debit.

Four-Leg Strategy: Iron Condor

The iron condor is a complex strategy, but it's goal is simple: to make a bit of cash on a bet that the underlying price won't move very much. Ideally, the underlying price at expiration will be between the strike prices of the short put and the short call. Profits are capped at the net credit the investor receives after buying and selling the contracts, but the maximum loss is also limited. To build this strategy, you buy a put, sell a put, buy a call and sell a call at the relative strike prices shown below. The expiration dates should be close to each other, if not identical, and the ideal scenario is that every contract will expire out of the money, that is, worthless.

Futures

Futures contracts can also be combined, with each contract constituting a leg of a larger strategy. These strategies include calendar spreads, in which a trader sells a futures contract for with one delivery date and buys a contract for the same commodity with a different delivery date. Buying a contract that expires relatively soon and shorting a later (or "deferred") contract is bullish, and vice-versa. Other strategies attempt to profit from the spread between different commodity prices, such as the crack spread (the difference between oil and its byproducts) or the spark spread (the difference between the price of natural gas and electricity from gas-fired plants). 

RELATED TERMS
  1. Short Leg

    A short leg is any contract in an options spread in which an ...
  2. Long Put

    A long put is buying a put option, which profits if the underlying ...
  3. Buy A Spread

    Buying a spread is an options strategy involving buying and selling ...
  4. Legging In

    Legging in involves establishing a spread or combination position ...
  5. Put

    An option contract giving the owner the right, but not the obligation, ...
  6. Bull Spread

    A bull spread is a bullish options strategy using either two ...
Related Articles
  1. Trading

    Pencil in Profits in Any Market With a Calendar Spread

    Calendar spreads are a great way to combine the advantages of spreads and directional option trades in the same position.
  2. Trading

    Strategies for Trading Volatility With Options (NFLX)

    These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility.
  3. Trading

    Bear Put Spreads: An Alternative to Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
  4. Trading

    What Is A Bull Put Spread?

    In a bull put spread, the options trader writes a put on a security to collect premium income and perhaps buy the security at a bargain price.
  5. Trading

    How to Sell Put Options to Benefit in Any Market

    The sale of a put allows market players to potentially own the underlying security at a future date, at a price below the current market price.
  6. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  7. Trading

    A Quick Guide To Debt Options

    Options on debt instruments provide an effective way for investors to manage interest rate exposure and benefit from price volatility, learn more today.
  8. Trading

    Understanding Bull Spread Option Strategies

    Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.
  9. Trading

    What is a Bear Call Spread?

    A bear call spread is an option strategy that involves the sale of a call option and simultaneous purchase of a call option on the same underlying asset.
  10. Investing

    Why Options Trading Is Not for the Faint of Heart

    Trading options is not easy and should only be done under the guidance of a professional.
RELATED FAQS
  1. What is spread hedging?

    Learn about one of the most common risk-management strategies options traders use, called spread hedging, to limit exposure ... Read Answer >>
  2. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
  3. What occurs when a security meets its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
Trading Center