Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Circling the RIMM


Impact of option expiration is overblown.

As the third Friday of February approaches, it brings with it the monthly question of how option expiration will affect the price action of both individual stocks and the broader market. This includes the raised-eyebrow queries regarding the concept of "pinning," or prices being drawn to a particular strike price.

First, I'd say the impact of option expiration is overblown, as it's akin to the tail wagging the dog. That is, it would take large open interest of a near-the-money strike -- let's say share equivalent of 25% of the underlying stock's daily average strike -- to override the prevailing news and influence "normal" price movement.

As far as pinning goes, yes - strike prices with large, open interest can act like a magnet, but remember: The force can be either of attraction or repulsion. Much depends on recent trading patterns. In a low-volatility environment, you might see more gravitational pull, or pinning.

In a high-volatility environment, such as the large daily price swings we recently witnessed, there might be the opposite, as traders need to defend positions. So, as a stock moves through 1 strike, those short options need to hedge and will buy or sell stock accordingly, which will exacerbate the price move and push the stock toward the next strike.

Research in Motion (RIMM) might provide a good example of how options can influence price as this Friday's expiration approaches.

Circling the RIMM

Shares of Research in Motion dropped over 8% last week after the company lowered earnings guidance. This generated heavy option volume. As of Friday's close, it was clear from the current configuration that the February contract revealed open interest in the $50 strike, which had over 23,000 call options and $15,000 put options.

Here's how the dynamics of pinning might play out in Research in Motion at expiration:

Imagine I'm long 5, $50 calls in Research in Motion. If the stock rises above the strike, I can look to take a profit either by selling the stock in an attempt to lock in a small profit, or by simply closing the position by selling out the calls. In both cases, this creates selling pressure and drives the shares back toward the $50 strike price. If I sell out the calls, they are bought by someone else, who now in turn might short shares of Research in Motion as a hedge (which again creates downward pressure).

This plays out on both the put side and the call side. The larger the open interest at the strike, the greater the magnetic pull. Most of this trading is done by market makers using their long gamma inventory as a way to scalp a few dollars on expiration day. Given that market makers tend to trade from a delta-neutral standpoint, in the absence of other outside forces, it's no surprise a stock's price hugs the at-the-money strike price.
< Previous
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos