Let us consider a put vertical spread structure. It is formed by simultaneously selling a put and buying a put below the strike price of the put. The same structure can be created without selling and buying them simultaneously. You can choose to buy the put first, then sell the higher strike put at a later date and vice versa. That is legging into a vertical spread. Legging into your positions is usually considered an advanced manoeuvre for more experienced traders.
Why would you want to consider legging into option structures? The main reason is to improve the reward to risk ratio of your options structures. However, you need to be pretty accurate in timing your actions in relation to the direction of underlying stock movements. If the stock doesn’t move according to your outlook then the reward to risk ratio can be worse off than not legging them in. To leg into a position successfully, you need to have a good sense of market direction. You can ride on the short-term mean reversion edge that exists in most underlying to anticipate the direction of the next move. You can refer to this article for more details on the concept of mean reversion.
LEGGING INTO AN IRON CONDOR
We will explore this legging in concept in greater detail by looking at the vertical iron condor structures. Suppose you intend to create an iron condor structure by legging in. You can choose to enter the put credit spread or the call credit spread depending on the current market condition.
If the underlying has been bullish been recently retraced back to a support, you can enter the put credit spread in anticipation that it will continue to resume its bullish trend. After it has moved up and has reached an overbought condition, you can now enter the call credit spread. This is how you can leg into an iron condor.
EXAMPLE ON SPX (10th Oct 2018)
This image is taken on 10th Oct 2018 before the market opens.
SPX is currently supported at the 50SMA(green) after several 3 days of down move. It is currently oversold on the 3-period RSI.
This is a good time to leg into a put credit spread. You can position the short strike at the white line which is approximately 1 ATR (grey box) below where SPX is currently trading.
If SPX moves up from here and approaches near all-time high of 2940 or when 3-period RSI registers an overbought signal, this is where you can look to leg into the call credit spread and complete the iron condor structure by positioning the short strike on the yellow line.
By legging into your call credit spread only after SPX has moved up, your spread will now be at a higher strike price as compared to if you had not legged in (blue line). This will give you a higher probability of success.
HOW TO LEG IN SUCCESSFULLY
- Plan your trades thoroughly before execution.
- Have a market bias. Use your charting skills.
- Identify areas of support, resistance.
- Identify overbought, oversold conditions.
Legging into your position is an advanced manoeuvre which requires good timing in order to achieve a good execution. When the market behaves according to your bias, a structure that is legged into will give you a better reward to risk ratio and a higher probability of success. As this is an aggressive approach, you might want to look at the scaling into your trade article for something more conservative.