Legging In

What Is Legging In?

Legging in refers to the act of entering multiple individual positions that combine to form an overall position and is often used in options trading.

Understanding Legging In

Legging in can involve establishing a spread, combination, or any other multi-leg position in options one leg at a time, rather than all at once as a single package. Legging in to a complex strategy can be advantageous to a trader if putting on the position one piece at a time will prove to be less expensive than establishing it all at once.

For certain complex positions, if a trader cannot find an eager counterparty who happens to have an axe to put on the exact opposite position, they may not find enough liquidity or a favorable price by quoting it as a spread. Instead, it may be better to leg into the spread one option at a time until finished. Upon taking off, or closing out, a complex position, a trader may similarly leg out of it.

Legging in is a common practice used to lower the overall cost when buying and selling complex strategies involving options and futures contracts. Spreading strategies in the options market is popular since it allows a trader or investor to customize a particular profit and loss structure when betting on a specific outcome or set of outcomes in the underlying security.

While there are several standard spreads and combinations, such as vertical call spreads, butterflies, or straddles, a trader can build whatever spread strategy they like. However, complex orders involving more than two options might not find a natural counterparty eager to take the other side of the trade, at least not for a favorable price level. When that is the case, it may be worthwhile and necessary to leg in to the spread piecemeal.

Legging In Risks

While a legging process may prove to be cheaper, it does come with some risk, known as leg risk. The risk is that the market price or liquidity in one or more of the desired legs will become unfavorable during the time it takes to complete the various orders.

This can happen because the underlying security moves sufficiently in between legging, or because of other factors, like a change in implied volatility. Additionally, while you are trading one leg, somebody else may effect a trade in another leg you are looking at purely incidentally.

Example of Legging In

Suppose a trader has a particular desire to enter into a complex multi-leg options strategy that involves buying the 30 – 40 strike 1 x 2 put spread in XYZ options and at the same time buying a 50 – 60 strangle.

The trader initially might quote the combined strategy as a package to see what people are willing to sell it at. If the offers in the market for the package are not to the trader's liking, then the trader may try to leg into the strategy by quoting the two spreads separately.

Perhaps the trader finds a good offer for the strangle, but is still unhappy with the 1 x 2 ratio put spread offer. So, the trader buys the strangle and then goes to the electronic market's screens to buy the 40 put by itself and then sells two times the 30 puts to a market maker on the floor. The trader has successfully legged into the full strategy.