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Setting Up Your Pins on Expiration Day


Stocks are most likely to close at strike when volatility is low and open interest is high.

Going to run through some pin thoughts tomorrow, so if you have any names to take a look at, by all means email or tweet it over, or leave it in a comment.

Would like to set the table with some general pin thoughts first.

Stocks have a modest tendency to pin (close at strike) on expiration day. A pin is most likely when volatility is low and open interest is high. Remember that volatility is a proxy for the trading range. If you divide the volatility of anything by the square root of 252 (the number of trading days in a year) you can get a "typical" trading range. The square root is 15.87, so let's call it 16.

So if, say, Apple (AAPL) has a 32 volatility, then we expect to see XYZ move less than 2% on about two-thirds of trading days. If XYZ has a volatility of 48, then we expect to see it move less than 3% on two-thirds of all days. Clearly a lower range makes it more likely to naturally hover near the current price than a higher range.

Open interest refers to the number of contracts outstanding on a given strike. Remember that options are a zero sum game. For every options long there's an options short. If volatility is low and especially if it's in a declining trend, it's likely that options owners are the ones facing pressure as expiration approaches. Their holdings are declining in value by the minute. And that decay gets exponential. They have pressure to either just sell the options or extract some value from them via trading the stock. A holder of a call that's modestly in the money will probably offer stock -- again and again, so long as the call remains in the money. On the margins, this serves to pressure the stock towards the strike price.

The lower the volatility and the higher the open interest, the more pressure this will apply towards the pin. And it's also important who actually owns the calls. If it's by and large market makers and other professional traders, than it's more likely they aggressively hedge their positions, and ergo more likely they cause a pin.

This is all very simplified. In reality, pinning is just one force on the margins, easily nullified by bigger trends. Not only that, it can all work in reverse. Consider a situation where volatility is increasing. Options shorts are now the ones under the gun and forced to chase strength and short weakness. And in that situation, high open interest actually causes stocks to move away from strikes -- the anti-pin.

Does this cycle lend itself to see many pins? It's questionable. Even though volatility is low in the general sense, it has actually trended flat to up modestly over the course of the cycle. That suggests MMs and the like aren't necessarily long gamma across the board. So we'll look for some open interest, but I suspect this week sets up as an island of volatility in an otherwise quiet summer.
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No positions in stocks mentioned.
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