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business newsExpiration Week: Defending Your Positions
How should shorts act in a high-volatility environment?
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The SPX options have peak open interest in the 800 strike, with over 150,000 calls still open. And there's scant volume, just 3,700 contracts so far today; meaning there's no rush to liquidate. These pups are still fetching around $2, so I imagine those short them are biting their nails, watching the hourglass for premium to drop a grain at a time.
But remember, the SPX option expiration has a wrinkle: The contracts cease trading on Thursday afternoon, but are settled based on Friday morning’s “special” opening price, or SET. The SET can often be well outside the true opening or even the daily trading range.
In Expiration Week: Will a Move in Motion Stay in Motion?, Adam Warner notes that expiration tends to see a follow-through on the most recent prevailing trend. More importantly, in a high-volatility environment, it forces those short options to defend their positions, as I discussed in Circling the RIMM:
"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."
We’re already seeing a big midday reversal. Now, I have to go defend my SPY position - which starts to get short right here.
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