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Legging Out Of Spreads

Posted by Pete Stolcers on June 12, 2006

In today’s option trading blog I want to address the mental anguish of legging out of spreads. Let me set the tone. Traders that have a losing spread position – leg out. Traders that have a winning spread position – leave it alone.

Let’s say that you were short the 70 – 65 put credit spread that expires in a few weeks. You sold the spread for $1 when the stock was at $74. You loved the stock and you could not envision it trading down to $70 even with the weak market backdrop. The earnings were good and technically there was upward momentum and support – the trade made great sense.

Now, in a matter of days the stock has been hammered. Out of nowhere the sellers have pounded it down to $67. Along the way you have decided that it is just a temporary sell-off and it will bounce. It is a good stock and it’s down because of the stupid market. Two days later, the stock continues lower and now it can’t find a bid. It is trading at $64 and you don’t know what to do. Let’s take a look at your options.

You could sell out the long put (65 strike) and carry the ITM short put (70 put) position. When you do this you have just removed all of your protection and greatly increased your risk. The original position was a probability play and you added plenty of cushion in case you were wrong. Now, assuming that you can shoulder the naked put margin, you are essentially long the stock. If you can’t afford to purchase the stock, you carry the risk of blowing out your account on one trade. The second you sell your long put you are stating. “THIS STOCK IS A BUY AND IT’S GOING UP.” I hope your timing is great because if it’s not, you will be sweating every tick. You have not doubled-up, you have probably quadrupled up. An initial spread delta of .25 has now turned into a stock delta of 1. If you get assigned and you can’t afford the stock, you will need to sell the shares immediately. If you stall, the brokerage firm will do it for you on their terms. In this case you were wrong the whole way and you refused to admit it.

Here’s another possibility. You suspected you were wrong long ago. You thought something was up when the stock started to slide so easily. Now it can’t find a bid. You decide that the only thing to do is to buy-in the short put (70 strike) and let the $65 put “run”. Heck, if the stock drops another $4 you might be able to scratch the trade. The problem with that mentality is you have done a complete 180. A few weeks ago you loved the stock and now you hate it. You will be second guessing yourself every tick of the way and your emotions will be on overdrive. If the stock reverses and heads back up, you will be kicking yourself for months. Even worse, the stock heads down and you convince yourself that this is some kind of repair strategy. Regardless, your risk exposure has increased dramatically from the initial position and your emotions will get the best of you. Scared money never wins.

If you can’t afford to carry the one-legged position overnight and you are attempting an intraday maneuver, the stakes are even higher. Assuming that your brokerage firm will allow this, you’re in over your head. If the stock makes one little head fake, you are hitting the panic button because you know you have to be out by the end of the day. You also know that in a very short amount of time you have taken a bad situation and made it worse. The stakes are high because your size is way out of line. Months of profit hang in the wind.

I have tried legging and I have witnessed it hundreds if not thousands of times. I have had to liquidate multi-million dollar accounts where the trader froze in the middle of the process. Trust me, the good does not come close to the bad. If the trade was put on as a spread, take it off as a spread. Take your lumps and move on.

If you can relate, share your experience good or bad.

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Option Trading Comments

  • On 06/13, Walt Sherman said:

    Good advice on getting out of the whole spread, but you didn’t do this with the GS 140/135 June put credit spread.  When I got the email to sell the 140 put, I immediately closed the entire spread.

  • On 06/13, Walt Sherman said:

    Correction.  I meant to say the order to buy the 140 put, not sell the 140 put.

  • On 03/21, Russell said:

    Does legging out and lifting a leg describe the same transaction?

    Or, Is lifting a leg removing one side of the spread and leging aout describe partial lifting of the total spread?

  • On 03/22, Pete said:

    Legging and lifting are synonymous. You are removing one side of the trade and your bias changes instantly.

  • On 07/23, Bryan said:

    Oh boy, can I relate to this.  Every single time I have tried to repair a losing spread by legging out, I have lost more money than if I had just sold or even held the spread.  Without fail, I close the wrong side of the spread and then the side I held moves against me.  This is how I lost most of my capital this year, and it was on a GOOG bear call spread when GOOG jumped back into the 500s, and on a AMZN bear call spread when it went (yet again??) higher from $68 up into the 70s.  When you think “it just cannot go any higher/lower than this!”, that’s the time to stop and find another trade somewhere else.  Believe me, I know.  wink

  • On 07/24, Pete Stolcers said:

    No one likes to lose money and it is a bitter pill to swallow. Mentally it’s even worse when you compound the problem. The stock already has you twisted because it did the unexpected. No reason to believe that all of a sudden you have “clear read” on it. Take your lunps - leasson learned.

  • On 01/08, Fin said:

    This is great piece of advise, only time I have seen it working when its going in the expected direction. If its expected to go further in the money closing short leg and initiating another out of the money short leg is one way to hang on to it.
    Leaving naked overnight is exposing to too much risk. Most of the time closing one leg leaves in the middle and turins winning trade into stock in the middle.

    This is a great learning site,

  • On 04/26, Brett Hansen said:

    The real point is - “your spread was your best play at where the market would NOT go"- well, it’s going there and now you want to try and leg out - meaning - “I now suddenly have realized where the market is REALLY going” = Yeah right!- Bottom line- you missed the first call on the stock- let it go and spread out of the loss before you prove you don’t know where the market won’t go. Baby steps is the key and minimize your risk.

  • On 04/26, Pete Stolcers said:

    Exactly. Admit when you are wrong and move on.

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