Pinning a strike may sound like a fight between wrestlers and baseball players. But rather, it’s something both stock and options traders can use to make profits. Pinning the strike takes advantage of the tendency of an underlying stock’s market price to close at or near the strike price of the same security’s heavily traded options as its expiration nears. This is a TENDENCY. It doesn’t always happen. But it’s more likely to occur when there’s lots of open interest AND the option is near the money. As an example, let’s say a stock is trading near $100. There’s heavy put and call trading for this same strike price as well. There’s a tendency for this stock to be “pinned” or stuck near $100 while traders unwind their positions at the expiration.
Stock markets with listed options are where pinning the strike most often occurs; however, it can occur for any options with an underlying asset. Pinning the strike most often happens when there’s a significant amount of open interest in both the calls and puts of a specific strike as their expiration approaches.
Why? Because an options trader’s exposure to gamma increases the closer they get to the contract’s expiration. Gamma exposure has the most significant acceleration into the hours just before its expiration.
As this gamma increases, minor changes to the underlying stocks price will significantly change the option’s delta. An options trader who is hedging to remain delta neutral must buy or sell an increasing number of shares of the stock to keep their exposure to risk in check.
Pinning the Strike Example
Let’s say Apple stock is trading near $146.61.
And there’s significant open interest of calls and puts with a 146.50 strike price. A trader who is long calls, as the stock increases…….
Their option’s delta will also increase. And with an even faster rate as the stock climbs. Therefore the trader will look to sell their stock at prices of $146.65 and lower. As a result, it pushes the price back to $146.50.
The hedged long put owner will also need to sell shares as the stock rises from 146.61 to 146. 75. Why? Because they already own shares to hedge against their long put. However, as the stock rises, their put options’ deltas increase at an accelerating pace, with too many shares being held long, prompting the need to sell. Which again pushes the price back towards 146.50.
Let’s say that the price then drops below 146.50 to 146.45.
Now, our call holder must BUY shares, because they will be short too many shares from their prior moves, now that the calls’ deltas have shrunk. Similarly, our put owner is required to buy shares because the put deltas are growing larger and larger, and they now don’t own enough shares of stock. This will push the price back to up 146.50….
When pinning the strike, options traders expose themselves to pin risk. Traders become uncertain whether to exercise their long options that have expired at the money. Or very close to it. Because concurrently, they’re unsure of the number of similar short positions they’ll be assigned when doing so.
The most considerable pin risk is when one side abandons its position allowing the other side to make more trades, driving the prices up or down quickly, disrupting the stock’s value. Wrong side holders will suffer severe losses with these sudden shifts.
Avoiding Pin Risk
You can avoid pin risk by closing a spread on options approaching their expiration, and this is particularly important if they are almost in the money. The best advice for traders is to close their position that may be in the money before the closing day expiration bell.
Market Makers and Pinning
Market makers create calls and puts, giving traders the right to buy or sell a stock at a predetermined price. If the price is advantageous to options holders, then the likelihood that a market maker will have to buy/sell the stock at the execution date is high.
Suppose the stock gets pinned near its strike for specific options contracts. In that case, there are likely many in the money put or call options that will lead the contract holders to exercise their options, resulting in underwriting firms having to buy or sell a large number of shares at an undesirable price.
Pinning a strike is a regular occurrence in the options marketplace. When strong open interest occurs with a specific options contract, the price of that security will stay close to the strike price on its expiration day. However, options holders should always be wary of pin risk and close positions near the strike before the bell.
As always, never open a position that you can not afford to lose, and good luck with all of your trades.