What it means
An option gives its holder the right, but not the obligation, to buy or sell an asset at a set price called the strike price. When the asset price is well above or below the strike on expiry day, it is clear whether the option has value and will be exercised.
When the asset ends right at the strike, the answer is uncertain. The problem falls on the seller, who is also called the writer.
The writer usually hedges (offsets risk) by holding or trading the underlying asset. If the writer assumes the option will expire worthless and removes the hedge, but the holder exercises anyway, the writer is left with an unwanted position.
Exercise decisions can be made after the market closes, within deadlines set by the exchange and clearing house. Options that are even a small amount in the money are often exercised automatically under clearing rules.
This means the writer may not learn the outcome until after trading has stopped. Pin risk is mainly a concern for market makers and traders with large option books.
A trader holding thousands of contracts across several strikes may have dozens of positions that close near the money. The potential exposure is multiplied across them.
Traders manage pin risk by closing or rolling positions before expiry, keeping their hedges in place, or trading out of options that are close to the money. Some also avoid holding large positions at the very last moment.
The cost of avoiding the risk is usually small compared with the cost of being caught. Finance teams at companies that use options for hedging, or that issue them to staff, may meet the idea indirectly.
The point to remember is that an option's final value is not known until exercise decisions are settled. Risk reports should therefore treat positions near the strike with extra caution close to expiry.
In practice
Real-world examples.
Example
An options market maker holds 500 contracts that expire with the stock sitting at the strike. She keeps part of her hedge in place overnight rather than guessing the outcome. The next morning she settles the position at a small cost.
Example
A fund manager who sold covered calls on a share holding sees the price close exactly at the strike. He is unsure whether his shares will be called away. He decides in advance whether he is content to keep or lose the shares, so the outcome is not a surprise.
Example
A bank risk officer reviews expiry day exposure and flags positions within 1% of the strike. The trading desk reduces these positions on Thursday ahead of Friday's expiry. The report shows a smaller worst-case loss.
Formula
Calculation
Unintended exposure = number of contracts x shares per contract x price move after expiry
A trader has sold 20 call option contracts on a stock with a strike price of $50, and each contract covers 100 shares. The stock closes at $50. Believing the options will expire worthless, the trader holds no hedge.
Some holders exercise, and the trader wakes up on Monday short 20 x 100 = 2,000 shares. The stock opens $3 higher at $53, so the trader must buy back at a loss of 2,000 x $3 = $6,000 on a position the trader did not plan to have.Case study
Seen in the real world.
Ashgrove Trading is a fictional options firm, and this case is illustrative. On an expiry Friday, one of its traders held a short position of 100 contracts on a stock closing at $80.02, with a strike at $80.
The trader judged the options would probably not be exercised and removed the hedge. Over the weekend, holders exercised, leaving the firm short 100 x 100 = 10,000 shares. When the stock opened 2% higher on Monday at about $81.60, the loss on the unhedged shares was 10,000 x $1.60 = $16,000, plus the cost of trading out.
The firm changed its policy so that any option within 1% of the strike must be hedged or closed before the final hour. The illustrative lesson is that guessing the outcome on expiry day is a bet, and the safer approach is to remove the uncertainty.
Watch out
Common mistakes.
- Assuming an option that closes at or near the strike will expire worthless.
- Removing a hedge before exercise decisions are final.
- Overlooking that exercise can be decided after the market has closed.
Questions
People also ask.
Who suffers from pin risk?
Mainly the option seller, since the buyer chooses whether to exercise.
How do traders avoid it?
By closing, rolling or hedging near-the-money positions before expiry rather than waiting.
Is it only a risk with stock options?
No, it can occur with options on indices, currencies, commodities and other assets, although settlement rules vary.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related