Beware of Pin Risk

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Options Expiration is just around the corner, and so we will start hearing about the "pin risk" in options along with the potential for certain names to "pin" at a strike option trading pin risk.

Option Pinning refers to price action in stocks as they come into options expiration. Option trading pin risk is often viewed as dark magicbut simply put it is when certain traders and market makers have an incentive to keep an underlying stock around a certain price. There is a problem with holding short options all the way to expiration, especially if they are at the money.

That means you have the obligation to purchase stock from the option owner if they decide to exercise their contract. Now the only time it is advantageous for an option owner to exercise is if the option is in-the-money. If you sold that AAPL put, do you really want to get assigned? Maybe, but then that leaves you with risk over the weekend, higher commissions, and it ties up your margin.

So option shorts often have an incentive to keep the stock price of the underlying above or below a certain strike price. The same occurs with sold calls. Price action around a pin often resembles a " damped harmonic oscillator. There is a price level, usually an option strike where price will attempt to move away-- and it will be met with a force that causes it to revert to this level, and potentially overshoot.

As the market heads towards option trading pin risk end of the day, the forces attempting to move it away from that strike will diminish and the amount of option trading pin risk required will be reduced as well. From what I've seen, the input that effects the trade the most is the amount of open interest on the strike relative to the average amount of shares traded.

This shows us how many traders and market makers actually have "skin in the game. If enough traders have skin in the game to keep it around that price, then the pinning supply and demand will be great enough for the effect to happen.

If not, then price action can be more random. The statistical efficacy of option pinning has come into question, and I can see why-- it's much more of a dark art and it is not as consistent as one may think. But when it does happen, you know it when you see it. This goes into some simple auction market theory. The stock market opens at 9: We usually have a good hour of trading, maybe 90 minutes-- and then often the volatility will settle down. This is because much of the large, institutional order flow occurs at the beginning of the day.

After the morning session is the best place to start scanning for pinning candidates. Soon lunch will come around, and then trading may pick up at the 2PM turn, but if levels are followed in some individual names then you may be able to pick up a trade.

First thing you need to have is a fairly liquid options board. The second thing you need to watch for is news risk. This can be beneficial in many ways as it often produces an enhanced pinning effect, or maybe an option squeeze if the move is greater than what the options are pricing in.

Learn about Earnings Risk. Better candidates will have a higher open interest at a pinning strike relative to the others. However, this does option trading pin risk guarantee a pin in any sort of way-- I've seen times in which the stock completely overran a level that many were expecting as a pin because of the huge open interest.

Look option trading pin risk names that could technically be settling down into a range. Often there is a support or resistance level that will help to keep prices close, and the market structure will actually provide reinforcement to the option trading pin risk. Also, consider only names that have strike price width of 5 or more. When you have names with closer strike prices, it affords option traders the ability to distribute open interest, which reduces the "skin in the game.

With those filters, you will often see that you go back to the same names over and over again. And that's fine-- each individual stock has its own personality that can only be learned with experience. This is a tough question, because there option trading pin risk many ways to trade the outcomes of the pinning effect. Play for the Pin This is a set of trades where you have high option trading pin risk that the underlying will stay at or near a strike going into the end of the day.

You are looking for a lot of theta, so you will be a net option seller. In exchange for the theta, you take on a lot of gamma risk-- option trading pin risk lose money on a fast move. Because of your belief in option trading pin risk pinning effect, you believe the gamma risk is mitigated.

Option trading pin risk of trades in this category are straddle sales, strangle sales, iron butterflies, and calendars. Play the Move then Pin This is a little more of an advanced trade. Simply put, you have a directional bias in a stock for 1 day but you think that a pin just above or below the price is very possible. There are also more advanced considerations, such as the implied volatility in the name as well as the potential to arbitrage short term volatility. Examples of trades in this category include ratio sales, broken wing butterflies, and out of the money calendars.

Play for the Blowout This kind of trade works when you believe that the short term supply and demand forces will greatly outweigh any sort of pinning option trading pin risk. This often comes on option trading pin risk back of a trending market or a stock that has just seen news released like earnings or sales numbers. With this trade you are willing to accept theta risk in exchange for the ability to profit on a fast move.

The benefit with this trade is that if you are right, the options will go full intrinsic and you will eliminate the theta risk option trading pin risk. Do note, there are some very different risks when trading opex. You are dancing on what I refer to as the gamma knife option trading pin risk, which is not a fun place to be when you are wrong. Opex trading requires a very disciplined mind and the agility to adjust positions quickly. Learn more about why beginners should steer away from opex.

That's a great question for a graduate student to cover in a thesis paper. I don't have any hard numbers, but I'll give my thoughts based on watching the market on opex this year.

The introduction of weekly options into many pinning option trading pin risk has a very specific effect. Those traders looking to take positions in the short term no longer have to use the front month options. So what do you think would happen here? Sure, the pinning effect should be reduced during monthly options expiration, and I think it has. But, much to my surprise, there has been a pickup in pinning effects in the weekly options. I don't know if this is quantifiably true, but the way that some of these weekly options trade on Friday lead me to believe that there may be a resurgence in the dark art.

If I missed anything or want to give me feedback, let me know in the comments section. I've put together an Iron Condor Trading Toolkit that gives you the case studies and training needed to be consistently profitable option trading pin risk the market. Click Here to Get the Toolkit. Below is a comprehensive guide to the mechanics of options pinning.

What is Option Pinning? Why Does it Happen? This creates a unique option trading pin risk of supply and demand only seen option trading pin risk we come into options expiration.

What does it look like? It resembles a child on a swingset who has stopped moving her legs, and is coming to a rest. Does it always happen? When Does Pinning Start? What are good pin candidates? Can I trade Option Pinning? I generally break it down into 3 categories of trades. T here is a way to structure your risk that makes some money if it stays at current price, more money if it goes to the pin, and losses if it overshoots the pin.

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Pin risk occurs when the market price of the underlier of an option contract at the time of the contract's expiration is close to the option's strike price. In this situation, the underlier is said to have pinned. The risk to the writer seller of the option is that they cannot predict with certainty whether the option will be exercised or not. So the writer cannot hedge his position precisely and may end up with a loss or gain.

There is a chance that the price of the underlier may move adversely, resulting in an unanticipated loss to the writer. In other words, an option position may result in a large, undesired risky position in the underlier immediately after expiration, regardless of the actions of the writer. Sellers of option contracts often hedge them to create delta neutral portfolios.

The objective is to minimize risk due to the movement of the underlier's price, while implementing whatever strategy led to the sale of the options in the first place. For instance, a seller of a call may hedge by buying just enough of the underlier to create a delta neutral portfolio. As time passes, the option seller adjusts his hedge position by buying or selling some quantity of the underlier to counteract changes in the price of the underlier. However, the cost to the option buyer of exercising the option is not zero.

For instance, the buyer's broker may charge transaction fees to exercise the option to buy or sell the underlier. If these costs are greater than the amount the option is in the money , the owner of the option may rationally choose not to exercise. Thus, the option seller may end up with an unexpected position in the underlier and thus risk losing value if the underlier's price then moves adversely before the option seller can eliminate this position, perhaps not until the next trading day.

The costs of exercise differ from trader to trader, and therefore the option seller may not be able to predict whether the options will be exercised or not. A trader has sold 75 put contracts on XYZ Corp. In fact, only 49 of the contracts are exercised, meaning that the trader must buy shares of the underlier. If at the close on Friday, October 19, the trader's position in XYZ stock was short 7, shares, then on Monday, October 22, the trader would still be short shares, instead of flat as the trader had hoped.

The trader must now buy back these shares in order to avoid being exposed to risk that XYZ will increase in price. On the day that an option expires—for U. A small movement of the underlier's price through the strike e.

For instance, if an option goes from being in the money to out of the money , the trader must rapidly trade enough of the underlier so that the position after expiration will be flat. These calls are out of the money and therefore will expire worthless at this price. These options are now in the money , and the trader will now want to exercise them. This is done so that the trader will be flat IBM stock after expiration.

The calls are now out of the money , and the trader must quickly buy back the stock. Option traders with a broad portfolio of options can be very busy on Expiration Friday.

Pinning of a stock to a particular strike can be exploited by options traders. One way is to sell both a put and a call struck at the pinned value. As noted above, stocks can break their pin and move off the strike, so the trader must keep a careful eye on his positions. In this market, the last available price of the underlier, which is used to determine whether an option is automatically exercised, is the price of the regular-hours trade reported last to the Options Clearing Corporation at or before 4: This trade will have occurred during normal hours, i.

It can be any size and come from any participating exchange. The OCC reports this price tentatively at 4: From Wikipedia, the free encyclopedia. Underlying Prices for Expiration" Accessed Jan 21, Energy derivative Freight derivative Inflation derivative Property derivative Weather derivative.

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