What it means
Many trades use more than one position. Each position is called a leg, and the legs are designed to work together.
The long leg is the one where the trader buys, expecting it to gain value or to protect the other leg. In an options spread, the long leg is the option bought, and the short leg is the option sold.
For example, in a bull call spread, the trader buys a call at a lower strike price and sells a call at a higher strike price. The long leg provides the main exposure, and the short leg reduces the cost by bringing in premium.
In a pairs trade, a trader buys one share that looks cheap and sells another that looks expensive, usually in the same industry. The long leg is the share expected to outperform.
If the market falls, the long leg loses value, but the short leg gains, so the position is less exposed to the overall direction of the market. Each leg has its own costs and risks.
The long leg usually needs cash to pay for the purchase or premium, while the short leg can create margin requirements or unlimited risk if it is not covered. Traders manage the position by looking at the combined outcome rather than at one leg alone.
Legs can also be closed at different times. Closing only one leg, for instance selling the long leg while keeping the short leg, can change the risk of the whole position.
Always check what remains after closing a leg, particularly when the short leg is left uncovered.
In practice
Real-world examples.
Example
A trader expects a share to rise moderately and uses a bull call spread. The call she buys is the long leg, and the call she sells is the short leg. The short leg reduces her cost but limits her gain.
Example
A hedge fund runs a pairs trade in the banking sector. It buys the bank it believes is undervalued, the long leg, and sells a similar bank it believes is overvalued, the short leg. If the whole sector falls, the short leg offsets part of the loss.
Example
An importer protects against a currency move by buying a call option on the foreign currency and selling a call at a higher strike to reduce cost. The purchased call is the long leg. The finance team records both legs in its risk report.
Formula
Calculation
Net debit = Premium paid on the long leg - Premium received on the short leg
Maximum profit of a bull call spread = (Higher strike - Lower strike) - Net debit
A trader buys a call at a strike of $100 for $6 (the long leg) and sells a call at a strike of $110 for $2 (the short leg). The net debit is $6 - $2 = $4 per share. The maximum profit is ($110 - $100) - $4 = $6 per share, and the maximum loss is the $4 paid. For one contract of 100 shares, that is $600 of maximum profit and $400 of maximum loss, with a breakeven price of $100 + $4 = $104.Case study
Seen in the real world.
Fairmont Asset Management is an illustrative, fictional fund that wanted to bet on a recovery in a retailer's shares without risking too much capital. It bought 20 calls at a $50 strike for $4 each and sold 20 calls at a $60 strike for $1.50 each.
The long leg cost 20 x 100 x $4 = $8,000, and the short leg brought in 20 x 100 x $1.50 = $3,000, so the net cost was $5,000. The maximum gain was 20 x 100 x ($10 - $2.50) = $15,000, which would occur if the shares finished above $60.
The share price rose to $57, and the fund closed both legs together for a good profit. The portfolio manager noted that closing only the long leg would have left a short call exposed to a sudden rise. The story is illustrative, but it shows why each leg must be understood as part of the whole.
Watch out
Common mistakes.
- Judging a spread by looking at only the long leg and ignoring the short leg.
- Closing the long leg and leaving the short leg open, which can create unlimited risk.
- Assuming each leg has the same margin and cost, when the legs may differ significantly.
Questions
People also ask.
What is the difference between a long leg and a short leg?
The long leg is the position bought, while the short leg is the position sold, and together they form the strategy.
Does every strategy have a long leg?
Most multi-leg strategies have at least one long leg, although some combinations can be built from short legs only, with greater risk.
Why use more than one leg?
Combining legs lets traders limit risk, reduce cost or focus on a view, such as the relative performance of two shares.
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