When we are looking to place a trade that has multiple legs, we might have to leg into a trade. By legging in, we mean that we will fill different parts of the trade with different orders. This is not something that we normally do. Instead we would look to fill the trade with one order. However, are there times that we might look to leg into trades?

Today, Tom Sosnoff and Tony Battista discuss how and when we would leg into trades. The guys explain why we will always try and fill the more "difficult" leg first. Difficult can be defined as the least liquid, the least efficient or having the widest market. We look to fill these legs first because we can assume that we will be filled on the more efficient leg closer to our desired price.

Next, Tom and Tony explain why you might look to leg into a pairs trade. They use a good example using the S&P 500 and the 30yr bond. The guys show why you would leg this pair and how to do it!

Tony Battista: Welcome back, my friend. Best Practices.
Tom Sosnoff: There's a rat in the kitchen and I don't want to know.
Tony Battista: It's Monday.
Tom Sosnoff: What?
Tony Battista: It's Monday.
Tom Sosnoff: Damn straight, yeah.
Tony Battista: Hey, Sexy Rexy's available for you. Just fired him.
Tom Sosnoff: Good, good, we'll take him. We'll take him. You know first quarterback perfect quarterback rating of the year yesterday, Geno Smith.
Tony Battista: Really?
Tom Sosnoff: First of the entire year. So, what was I going to tell you? So a little boom town, rats followed by a little rat in the kitchen. It's our Monday morning rat show. I saw a giant rat hanging out guarding the garbage this weekend. I was throwing out my -
Tony Battista: Guarding the garbage?
Tom Sosnoff: He was guarding the garbage. Sitting on top of my garbage can. He was. I couldn't decide -
Tony Battista: When are you coming out to the burbs?
Tom Sosnoff: What?
Tony Battista: When you coming out to the burbs?
Tom Sosnoff: I was going to come out this weekend and help you know.
Tony Battista: You decided to stick around.
Tom Sosnoff: Yeah, you know, I sensed you needed help putting together you skating rink.
Tony Battista: That's all right, I had Eric come over.
Tom Sosnoff: Perfect, I sensed you needed help but I decided to pass.
Tony Battista: I think we can handle it on our own. We have to learn from our own mistakes.
Tom Sosnoff: Yeah, you know I was busy. Doing man stuff. I was climbing ladders, changing light bulbs. I was climbing ladders.
Tony Battista: Did you finally change that light bulb?
Tom Sosnoff: No, I didn't. I didn't have the right kind of light bulb. It's special, a new aged light bulb. I probably have to order it on the internet somewhere. I have new aged light bulbs.
Tony Battista: Mm-hmm
Tom Sosnoff: Yes. I was much better doing my floral arrangements.
Tony Battista: I bet you are.
Tom Sosnoff: All right, so we have a new segment called "Legging a Trade". Ready?
Tony Battista: Yep.
Tom Sosnoff: So I did a little legging. I don't usually do a lot of legging. But I did some legging Wednesday of last week. I was sitting there looking at my position and all of a sudden bonds, which I've been short bonds. All the way to [inaudible 00:02:19] 146, all the way up to 146.12. And on Wednesday morning bonds were down, the market was kind of not doing much of anything and bonds were down a half a point. And I said, you know what, I'm going to take my first leg in a long time.
Tony Battista: So we had short …S&P's and short bonds basically one to one.
Tom Sosnoff: Yeah, and I have a pretty big position on leg. Not enough that I would have to report it to the -
Tony Battista: It's not as large as we've ever had, but it's certainly large.
Tom Sosnoff: Not at the level that we would have to report it to the-
Tony Battista: Feds
Tom Sosnoff: To the CFTC. But I have a pretty big position on it, in fact I traded a lot of bonds on Wednesday. Probably more than most customers.
Tony Battista: It was like a point and a half lower. Like at 142.
Tom Sosnoff: I started buying at 142.18 down to 142.12 and 75% of my short bonds in.
Tony Battista: There almost 144 now.
Tom Sosnoff: I know. It's one of the best legs that I've taken in forever. In all of 2014. I don't do that very often, but occasionally we do it. We don't talk about it on the show, because we show it through bob, we show the transparency of that, but we don't talk about it very much because if it is something you get away with every once in awhile, that's cool.
Tony Battista: Of course. And when it goes the other way then - right -
Tom Sosnoff: It's like an onside kick. It's like going for it on 4th down. If the statistics, when I say statistics in this case, the only statistics was the price extreme for me. Which I don't even know how much that counts. Gut, or whatever it is. So we don't talk about it that often, but we said to the guys, "Let's do the best prices on it. Legging a trade, let's see what's there. Maybe there is something that people can pull out of it." Again, we don't do it a lot. We don't teach it, we don't recommend it, but we occasionally do it. And I just gave an example on Wednesday. On Friday I legged a trade. I was buying VIX Futures first and as soon as I got filled I did VXX, because you leg the most difficult side. And so we will just go over some criteria.
Tony Battista: So you didn't wait to work itself out, once you got filled on the other one. That's how the product has to be traded, because you can't do it as one trade.
Tom Sosnoff: My bond trade for S&P's, I will not be covering this at all. So if S&P's go down to 2000, maybe I'll take some S&P's in. If bonds go back up to 146 or 145 I'll lay them back out. But this is not a trade where I'm trying to scalp it and get out of it.
Tony Battista: In Michigan, a few people are going to appreciate, Rad, Popper and Dino and a bunch of other people. Michigan does lose to NJIT, New Jersey Institute of Technology. It was 70 to 72. It was close.
Tom Sosnoff: I don't think your fanbase cares. They also lost some other games to division 2.
Tony Battista: It was close.
Tom Sosnoff: Anyway which leg do you, which side to you leg first when your legging something? You always work the most difficult side, always. Anything that you do in life. You do the difficult one first. You never do the easy one. People sometimes say to us, "Should I buy back these options? They're only a nickel. Should I buy back these? They only a dime." No, not really. "Should I buy back these options? They're a penny wide." No, because the side of short is much bigger.
Tony Battista: I made money on this side. Maybe I should cover that, right?
Tom Sosnoff: You’re always going to do the most difficult side first. You're going to use a limit-order at your price, because once you get the difficult side done, the other side is easy. And it's the same thing in business. If you run your own business you're very aware of this: always do the most difficult deal first. It's always easy. If you're hoping to close a deal on something you don't order the stuff you need to make that deal happen until the deal is actually closed. Close the deal first, then order the stuff you need. You can always get the stuff you need. Difficult can be defined as the least liquid, least efficient, and having the widest market the bid has spread. So I think that's all common sense. How do you define difficult? Difficult is the least liquid.
Tony Battista: Agreed.
Tom Sosnoff: It's one of those things I've always wondered about.
Tony Battista: I just talked about Bit Coin with you, it's probably one of the least liquid
Tom Sosnoff: One of the reasons we say you can't buy volatility is because in order to buy volatility you have to place to store it, to inventory volatility if you buy it. And the problem with buying something and inventorying something is you don't know when you can sell it. I much prefer executing the most difficult side first, which is getting rid of something and then finding out where to buy it from. There's always stuff for sale, but you can't always sell stuff. Take it when you can not when you have to. Difficult can sometimes be defined as the largest delta - biggest risk to the counter party, that's the easiest way to to understand this. What has the biggest risk? That's the most difficult thing. Legs can also be determined by available capital and account limitations, long side first. So the only thing that changes the equation is if you can do something the other way. Like if you're in an IRA count, you can't leg the short side first.
Tony Battista: Like let's say if you want to do a covered call, you can't sell the call first and then buy the stock.
Tom Sosnoff: That's right. So you have to do the long side first. So there are certain limitations, there are certain times when you have to do the less liquid side first. But that's usually determined by regulatory limitations or available capital. So when do we leg? We leg when the products being traded are not supported by a single fill. That's one reason. so there are different products, like I have some options of Futures, which we don't currently support that exchange. so I have to leg those trades. When the other side has limited risk due to price, meaning that when the market on the other side is five cents six cents, it's not going anywhere. The worst that's going to be is six cents seven cents, don't even think about it. So when you want to escalate your trading to another degree of risk altogether, when it's acceptable risk: that's when you leg a trade. When the bid and ask are resting at natural you are not filled because the orders are on different exchanges. Those are different times when it's bid somewhere, it's offered somewhere, but you can't do it on a single exchange, so you kind of have to leg it if you want to get filled at those prices.
Tony Battista: Fair enough, sure. Sometimes you can't get enough on one side. Like let's say you might be hitting a bid and taking an offer you only get filled on half your order. Then you might want to leg.
Tom Sosnoff: Yeah. So sometimes. You're looking at a trade and you're doing it really small, that's acceptable. That amount of risk, I'm willing to take a few dollars at risk to maybe save myself a few dollars.
Tony Battista: Right.
Tom Sosnoff: Do I do that every time? No of course not. It's not worth it. It's not worth the time. It's not worth the resources, whatever it is. But sometimes, eh what the hell. And then other times when the bid and asker are two different exchange and you're just not getting filled at where you want to be. So when quick execution is necessary, for example: short an iron fly as an earning play - of course, you're not going to have time! You want it, boom. You want quick execution and move on to the next trade. When you're short a strangle and one side gets blown out so you decided to leg out of the losing side to stop the bleeding or something like that. Hey, you know what? It's all about quick execution. Your resources generally need to be offensive, so when you're using resources to play defense you tire yourself out. You always want to keep the other side on the defensive.
Tony Battista: Yeah. That's the best use of time.
Tom Sosnoff: Correct. In order tot do that, use your resources and don't worry about legging stuff that you don't need to leg. When do we not leg? When making most spread trades. Defined risk, there's no value added to legging. There's none. We never do it. You never see us do it on the show. We never leg a trade when it's a defined risk trade. Why?
Tony Battista: Especially when the markets are so tight.
Tom Sosnoff: We don't have to have it that bad. All we are going to do is put ourselves in more trouble and frustrate ourselves more, we don't get filled. You achieve better pricing when you don't leg, that's an absolute. Everybody thinks they can leg there way into this stuff. I once saw somebody sell a course on legging. They were going to teach you how to leg. I'm thinking to myself, "teach me, teach this person, teach seven thousand professional traders because they'd love to know how your course is going to -" you can't get a better price than having the lowest common denominator around the counter party risk. That's the cheapest way to leg. I'm sorry, that's the cheapest way to execute an order, just fill the order. You're generally only adding incremental values, so adding exponential risk doesn't make any sense. That's common sense. And it's not a mechanical solution to a logical trading methodology. If your trading methodology is X and you're trying to give up as little to the counter party as possible in order to be as successful as possible you can't run the risk running with that set of mechanics.
Tony Battista: Sure you're going to be right for a penny or two or three, and you're going to be losing dollars.
Tom Sosnoff: Right. As long as you also commit to a bit of scalping, a little bit of capital to naked options, you're always going to have plenty of situations when you can use up all your legging. You want to show what a genius you are? There's plenty of positions where you can show what a genius you are. Like I used to think I could leg on everything but the answer is you can't. Even professionals that have edge in the sense that they're buying the bid and selling the offer, are taught first thing: no legging. We would send kids to the floor in there first effort in trades and start off and whatever, and we would say, "Listen, I know you think you're a genius. No legging."
Tony Battista: We've changed the no hero crap. It's the same thing.
Tom Sosnoff: It's the same thing. So if a professional the answer is: you spread it off, you make your trade, spread it off and move on to the next trade.
Tony Battista: You're trying to buy the spread, you bought something on the bid, you might offer the offer for a second, and then you hit the bid so you have the spread on it. The position is more important than the penny.
Tom Sosnoff: There's 10 other geniuses there right with you. Okay? Just remember that. So. Should I ext the winning side of a strangle or an Iron Condor to lock in that part of a profit? Should I leg out of one side? And the answer is: no, we don't do that at all. We don't manage winning sides of a trade because it's the entire trade. It's all or nothing.
Tony Battista: That's not what we mean by managing winners.
Tom Sosnoff: That's right.
Tony Battista: Mm-hmm.
Tom Sosnoff: How…. do you leg into a futures pair?
Tony Battista: One whole position.
Tom Sosnoff: So, why aren't futures pairs tradable as a single order? Great question.
Tony Battista: That is a great question.
Tom Sosnoff: Great question. Why aren't…futures pairs-
Tony Battista: Especially if the futures are on the same exchange.
Tom Sosnoff: Why aren't futures pairs tradable as a single trade? Great question. Write to your congressman. Because I've been arguing for this for 25 years.
Tony Battista: Mm-hmm.
Tom Sosnoff: But when we trade futures, different futures, as a pair, we typically execute one order and once filled, we'll hit the bid or offer on the other order. That's the best way we know how to do it. So, we'll rest our bid, we'll rest our offer on one future and as soon as we get filled, we'll hit the bid on the other one or take the offer on the other one. I don't know of a better way to do it. Why aren't they executed as a single pair? Because nobody wants to give up the edge. Which is a mistake, because if they did give up the edge, and only took one edge instead of 2, they'd have a ton more business. Exactly right.
An example of a futures pair trade that we sometimes use is short/ES and short bond futures. This is a position that we have on right now. And as you can see here, a lot of times, I'll just go to blast all and send them simultaneously. If you're talking about the 2 most liquid products out there and the markets are one tick wide, I don't even mess with it.
Tony Battista: Sure.
Tom Sosnoff: Occasionally, like the other day, on Wednesday, I legged out of one side and that's throwing a big nut out there. Sometimes, I'll leg a trade real small like I did on Friday morning - I put on some pairs, of which right here-
Tony Battista: If we have a pair straight on, sometimes we'll look at the one that's moved the most like if we were thinking that we were doing a basis trade like .. and P's and NASDAQ, for argument's sake, you're long one and short the other and the one that's moving your way has moved a lot more than the other. Meaning, the one that you're long is basically staying there, and the one that you're short has gone down. Maybe you'll take that one first and do the other one. But if 6 of one half does have another. What you're looking to is just to get the pair put on, and then you're just looking to take the pair off.
Tom Sosnoff: Yeah. I legged really tight pairs on Friday, NASDAQ, Notes, and S&P's and bonds, and what I mean by tight pairs is they're one tick wide. This is like a full-on one side. I immediately executed the other side.
Tony Battista: Plus you got to take into consideration the day, also. Like when you have a day like Friday where it's not very busy and you don't have a lot of movement, and there's not a lot of….-
Tom Sosnoff: There's a lot of scalping. I mean, I scalped some pairs for some fun. I was just looking for trades to make and that's another reason. What about a futures/options pairs? Same thing here. We trade futures and options as a pair, mostly for hedging purposes, we have to leg. So there's certain situations where it's either not supported by the technology you're using, in this case, it is supported by the technology, but it's not supported by the exchange. And usually, you route the options first because options and futures are generally less liquid than the futures themselves. And in most cases, the derivative is always going to be, think about it for a second, the derivative would have to be, pretty much, less liquid. Unless you're down to such a small delta.
Tony Battista: Sure.
Tom Sosnoff: But, generally speaking, the derivatives are, you know, a little bit less liquid than the underlyings themselves.
Tony Battista: Mm-hmm. Good.
Tom Sosnoff: And so if you have an illiquid underlying, you're going to have an illiquid derivative.
Tony Battista: Let's take a quick break, we're going to come back, we've got the opening bell next. This is tastylive live.