Multi leg option strategy combines different kinds of options with each other to create a complex strategy in which all the parts are executed at the same time.
The four kinds of contract are long call (buy a call option), long put (buy a put option), short call (sell a call option) and short put (sell a put option). By combining these options with each other, traders can construct complex bets on future price movements, limit potential losses and leverage potential gains. It’s even possible to use arbitrage to capitalise on rare market inefficiencies.
Here are some of the different kinds of multi leg options:
Long Straddle: This is a two leg strategy composed of a long call and a long put. It is used when a trader is confident that an asset’s price is about to change drastically, but does not know which way it will move – whether it’s going to crash in a big way, or rise hugely. The trader takes a direction-neutral position and profits if the price goes up/down by more than the price they paid for the two contracts (plus fees). They only lose money if the price fails to move.
Collar: This is a three leg strategy comprising:
- A long position in the underlying asset
- A long put
- A short call
The trader is betting that the price of the asset will go up, but is hedging the bet with the long put to limit the potential for losses. They are then hedging again with the short call, which will offset the price of the put and therefore will lower the net debit. This strategy is usually used by traders who are only slightly bullish, and who don’t expect a large increase in the price of the asset.
Iron Condor: This is a four leg strategy which is very complex and will limit risk. It has a simple goal: to make a small profit on a bet that the underlying price won’t move very much. The four legs are:
- Buy a put
- Sell a put
- Buy a call
- Sell a call
The trader hopes that the price at expiration will be somewhere between the strike prices of the short put and the short call.
Remember, options trading involves risks, including the potential loss of your invested capital. These strategies are complicated. It’s crucial to conduct thorough research, seek professional advice if needed, and start with small, manageable positions as you gain experience and confidence in trading options.