DEFINITION of Short Leg
A short leg is any contract in an options spread in which an individual holds a short position. If a trader has created an option spread by purchasing a put option and selling a call option, the trader's short position on the call would be considered the short leg, while the put option would be the long leg. Multi-legged spreading strategies can have more than short leg.
BREAKING DOWN Short Leg
Option spreads are positions created by options traders by simultaneously buying and selling option contracts, with differing strikes or different expirations, but on the same underlying security. Option spreads are used to limit overall risk or customize payoff structures by ensuring that gains and losses are restricted to a specific range. Additionally, option spreads can serve to bring the costs of options positions down, since traders will collect premiums from contracts in which they short.
Options spreads can be made in all sorts of configurations, although certain standard spreads such as vertical spreads and butterflies are most commonly put to use. 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 said to be 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.
Examples of Short Legs
A spread, as opposed to an options combination (such as a straddle or strangle), will always involve one or more short legs and long legs. The short leg(s) is/are those that are created by selling options contracts. In a bull call spread, for example, a trader will buy one call and at the same time sell another call at a higher strike price. The higher strike call is the short leg in this case.
There can also be more than one short leg. A trader may buy a call condor, where they purchase a low- and a high-strike call and at the same time sell two calls in between those strikes so that all four options' strike prices are equidistant. For example, the trader may buy the 20 - 25 - 30 - 35 call condor where they will buy the 20 and 35 strike calls and sell the 25 and 30 strike calls. The two calls in the middle (at the 25 and 30 strikes) would be the short legs.