What it means
An option's strike price is the price at which the holder can buy or sell the asset. Some strikes attract much more trading than others, usually round numbers such as $50 or $100.
Near expiry, the price of the stock can appear to be drawn towards these strikes and stay there. One common explanation involves hedging.
Market makers who have sold options hedge by buying or selling the stock, and the amount they must hold changes as the price moves. When the stock rises above a strike, hedging can lead to selling, and when it falls below, hedging can lead to buying, which pushes the price back to the strike.
Another explanation is that traders with large option positions have an interest in where the stock closes. A holder who would gain from a closing price at the strike may try to nudge the price there, or a seller may try to keep the options worthless.
Regulators treat deliberate price manipulation as misconduct. Research has found signs of the effect in some markets, though how strong it is and what causes it are debated.
It is not a guarantee, and prices often close far from the strike. Treating it as a rule is a mistake that can lead traders to take positions that lose money when the pattern fails to appear.
For traders, the concept affects choices on expiry day. A seller of options at a heavily traded strike may be more careful about holding positions to the end, and a buyer who needs the stock to move may find it unwilling.
The risks in such cases are tied to pin risk, which is the uncertainty over whether an option will be exercised. Non-specialists meet the idea in market commentary about monthly or quarterly option expiry.
The practical lesson is that prices around those dates may behave differently from normal days, partly because of derivative positions rather than company news. Long-term investors usually need not act on it but should not read too much into moves on expiry day.
In practice
Real-world examples.
Example
A stock trades at $49.20 in the morning on expiry day and then drifts to close at $50.01 with heavy trading in the $50 options. A trader notes the close as an example of pinning and records it in her journal. She does not assume the pattern will repeat next month.
Example
An options desk sees that open interest at the $100 strike is far larger than at any other strike. It plans its hedging for expiry day and avoids holding large positions at that strike into the close. The desk limits its exposure to surprises.
Example
An investor planning to sell shares sees that the stock has hovered at $75 all afternoon on expiry. He decides to wait a day rather than sell into what looks like an expiry effect. The price moves freely the next morning, and he sells at a slightly better level.
Case study
Seen in the real world.
Greystone Derivatives is a fictional trading firm, and this case is illustrative. On the monthly expiry day, its analyst noticed that the shares of one company had open interest of 80,000 contracts at the $60 strike, far more than at any other level.
Through the day, the stock traded in a narrow band between $59.70 and $60.30, even though a market news item suggested it should rise. The analyst calculated that the contracts at that strike covered 80,000 x 100 = 8,000,000 shares, so hedging flows were large relative to normal trading volume.
The firm decided not to take a directional view on that stock at expiry, and it reduced its positions at the $60 strike. The next month, the same stock closed 4% away from its busiest strike, which reminded the analyst that the pattern is only a tendency. The illustrative lesson is that heavy option positioning can influence prices around expiry, so traders should plan for it.
Watch out
Common mistakes.
- Treating pinning as a guaranteed pattern, when many expiries show no pinning at all.
- Assuming that a close near the strike proves manipulation, when hedging can explain it.
- Reading expiry day price moves as news about the company.
Questions
People also ask.
What causes pinning?
The leading explanations are hedging by market makers and positioning by traders with large option holdings.
Does it happen to every stock?
No, it is mostly seen in stocks with active option markets and heavy open interest at certain strikes, and even then not on every expiry.
Is it the same as pin risk?
No, pinning is the price pattern, while pin risk is the danger an option seller faces when the price ends near the strike.
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