Expiration and Strike Pinning

by CC May 18, 2012 1:07 pm • Education

Enis mentioned something about stocks being pinned on Quick Hits a little earlier. We got a few questions asking how exactly this works. I’ll give a little primer. Pinning is not some big conspiracy, it is simply a result of the effect that gamma and deltas have as they approach expiration. We’ll use BAC as an example because that looks like it could be a prime example today. In fact, Dan mentioned this morning about 15 minutes into the trading day that he thought BAC was going to get pinned on our long 7 put strike. We then made a decision to sell out of half of our position in that line due to the fear of it being pinned.

Here’s how it works. When delta neutral options traders are long options on a strike, the gamma of those options means that as the stock goes above the strike, they have deltas to sell in the stock, when it goes lower than the strike they have deltas to buy in the stock. Far away from expiration, that process is muted because the gamma of a far out option is small. But as you approach expiration the gamma grows exponentially until the moves in the stock above and below the strike price are 100 deltas in the minutes before expiration.

What this means is that collectively all of those traders and their gamma can effectively pin a stock to that strike as it gets close to expiration. For example in BAC, with open interest over 200k contracts on the May 7 line, every time BAC goes below 7 today, there’s a ton of stock being bought by traders to get delta neutral, when the stock goes above 7 a ton of stock to be sold. This causes the stock to settle in at the 7 level unless, as Enis mentioned, the market unhinges it from that level with a strong move one way or the other.

The opposite can be true of a line where most traders are short a strike. A stock move can accelerate through a line as the traders have to reverse scalp in the stock to stay delta neutral. You’ll see this in the market when volatilities are exceptionally high with most traders short strikes at high levels. This can give an already volatile market the equivalent of steroids.

Anticipating pins in general is more an art than a science, and even the most experienced option traders might be wrong footed once in a while.  But it’s worth paying attention to in case you approach expiry with option strikes that might potentially pin.