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Determining the Configuration of an Index Option


They're like magnets: Depending on alignment, they attract or repel.

Professor Warner discusses some of the dynamics that lead to pinning action on option expiration. And as he rightly notes, while the hedging activity will tend to draw prices to the strike price, he also adds that options can lead to an increase in volatility or an "anti-pin." Put another way, options are like magnets -- depending on which way they're aligned, they can either attract or repel. Which force prevails -- if one does at all -- depends upon the current trading environment, the amount of open interest relative to the outstanding shares and average trading volume, volatility levels, and who owns the bulk of the option open interest. The basic conclusion is that high open interest coupled with low volatility is conducive to pinning action.

Another important consideration regarding the open isn't just the number of contracts but also the configuration. That's the number of calls relative to puts. If there's a good balance or an equal number of calls and puts at a given strike price, that would tend to contribute to the pinning action.

In looking at the open interest of a few of the popular index products, it's interesting to note that the configuration this month is very lopsided to the put side. For example: In the Spyder Trust (SPY), the only strike with an equal number of puts and calls is the $100 line in which about 160,000 contracts of each are still open. As you move down the chain, the open interest in puts swells while calls diminish. To wit: At the $98 strike, there are 192,000 puts compared to 86,000 calls. Overall, the 5 strikes from $95 to $99 have a total of over 800,000 puts, but 350,000 calls. The open interest in strikes above $100 shows the opposite with about twice as many calls than puts, but overall open interest in the higher strikes is about half of that below the $100 level.

The NASDAQ 100 Powershares (QQQQ) has a similar option open interest with the at-the-money $38 strike having 490,000 puts open to just 140,000 calls. Again, as you move lower, the amount of puts is more than double the number of calls
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