When trading an option spread such as a Vertical Spread there are two ways to establish the spread. One way is to trade it as a spread. That’s what we recommend. The other choice is to leg the spread. That means placing one side of the spread first and the other after it. We do not recommend doing this. Why do we believe that trading the spread as a spread at order entry?
An example of the profit/loss versus the stock price when selling the $55/$60 Vertical Call Spread in XYZ stock trading at $50 was displayed. we may enter the position all at once, or enter each leg separately. An example of the P/L versus the stock price in a best case scenario of being able to leg a spread and improving our cost basis by 0.10 was displayed.
An example of the P/L versus the stock price in a worst case scenario in legging a spread was displayed. The example showed that while legging the stock moved and got away from us changing the risk/reward scenario of the entire trade. We could turn what might be a winning trade into a loser because we were temporarily wrong in direction. It’s especially bad for a trader with a tastyBITE-sized account who does not have the funds necessary to cover the margin costs of naked shorts and still have a large enough number of occurrences to let the “Law of Large Numbers” work.
For more information on Legging Spreads see:
Best Practices from December 29, 2014: "Legging A Trade"
Options Jive from November 6, 2015: "Legging Spreads for Better Prices"
Best Practices from March 2, 2015:"Legging The Market"
Watch this segment of tasty BITES with Tom Sosnoff and Tony Battista for the important takeaways and the reasoning why we should avoid legging into spreads, especially in a tastyBITE-sized account.
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