Weekly Options: Stocks "Pinned" Every Friday?
Weekly Options: Stocks ìPinnedî Every Friday?
As an options expiration day arrives, traders note that stocks sometimes get ìpinnedî to a specific strike price. But now that every week is an expiration week for a select group of stocks and ETFs, will we see this phenomenon every Friday?
As mentioned in an earlier post, the CBOE has added weekly options covering a select group of stocks, ETFs, and indexes. These new CBOE ìWeeklysî let you buy or sell options that expire in about 7 days.
Iíll explain why stocks can sometimes get pinned to specific levels, but first, letís review an example from the week ending July 23.
Apple: Resistance at $260
Apple (AAPL) is one stock that now has weekly options. As this 10-minute bar chart shows, the stock opened above $265 after the July 20 earnings release, but dropped in the first few minutes of trading. For the next 3 days, there was strong resistance at $260.
The most active weekly options that expired on July 23 were at the 260 strike. Almost 54,000 of these 260 calls and puts traded that day.
This volume represents the equivalent of nearly 5.4 million shares of Apple stock ñ a significant portion of the 19 million shares of the stock that traded that day.
Pinned to a strike: Expiration day positioning
Was Apple ìpinnedî to this 260 strike price? If so, why does this happen?
Many traders want to close their options positions before expiration. If youíre long a 260 call, for example, selling that call back might be preferable to possibly being assigned a long position in the stock.
But who will buy that call? If it only has a few hours until expiration, then itís likely to be a market maker (or other professional trader or dealer).
Market makers, however, usually donít want to take on expiration risk. If they buy a call, theyíll sell stock to neutralize their risk, putting downward pressure on the stock.
But if the price goes below 260, traders who own 260 puts will want to sell those puts. As market makers buy those puts, theyíll buy stock to compensate, creating upward pressure on the stock.
When open interest at a strike is high enough, this back and forth arbitrage between options and stock can make it seem as if the stock is ìpinnedî to a strike.
A more technical explanation: Delta and gamma
The blog ìTrading Nerdî has a more technical explanation of how market makers (or ìdealersî) tend to generally maintain a delta neutral position:
If the options-trading public, as a whole, are net-sellers of XYZ options, then the dealers will be net-buyers of XYZ options.But Trading Nerd also points out that on most days, usually ìthings arenít so ëjerky,í meaning that dealers typically make several small moves to re-hedge, not fewer large moves.î However:
The dealers are delta-neutral, but because delta is ever-changing (it is ìdynamicî), a small move in the price of XYZ stock can cause that dealerís portfolio to have a slightly positive or negative deltaÖ
Because the dealers are net-long XYZ options, they are also long gamma.
Since the dealers are long gamma, they must buy stock as the stock moves lower and sell stock as it moves higher (meaning that they must ìfadeî the market to remain delta neutral).
As expiration approaches, gamma increases (for at-the-money and near-the-money options), which means that the influence that options have on stocks also increases.What Trading Nerd is saying is that option prices get extremely sensitive on expiration day, noting that ìItís not too difficult to see why a stock that has a high amount of open interest (in at-the-money and near-the-money options) in relation to its volume on a given options expiration day will ìpin,î or nearly ìpin,î a strike price when options expire.î
Itís also worth noting that, as an optionís implied volatility decreases, the gamma on those options increases (for at-the-money or near-the-money options), which acts as another influence causing options to gravitate towards a strike price.
Just to clarify his point on gamma, hereís a chart showing how the gamma of a theoretical $50 call option at that price quickly rises as expiration nears:
Strike price pinning is by no means a certainty, but this type of price action may become more common as every week becomes an expiration week for a growing list of stocks and ETFs.
The Greeks represent the consensus of the marketplace as to the how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.
While Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security there is no guarantee that this forecast will be correct.
While Gamma represents the consensus of the marketplace as to the amount a theoretical optionís delta will change for a corresponding one-unit (point) change in the price of the underlying security there is no guarantee that this forecast will be correct.
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