Options Expiration: Strike Price “Pinning” Explained

A long time ago, in a galaxy far, far away from here, options watchers used to obsess over “expiration pins.”

That’s what we call it when a stock closes on expiration day right at, or very near, a specific option strike price. Traders used to swear that strike prices would pull stocks towards them like the Death Star hauled in the Millennium Falcon in Star Wars.

That may be an exaggeration, but there could be some factual basis in these anecdotal observations. A study about 7 years ago showed stocks closed within 25 cents of a strike price on expiration day modestly more often than on all other days. And that phenomenon seemed to be confined to stocks with listed options, suggesting the mere presence of options available contributed to this so-called pinning to a strike price.

This does make some sense given how stocks are bought and sold (sometimes sold short) on expiration days.

I’ll explain why, but before I do, let me clarify that the trading that can go on during an expiration day involves taking advantage of small price movements. Given the cost of option commissions and the potential difficulty in shorting a stock at any given time, this type of trading isn’t something most investors can take advantage of.

Option decay: When outcomes become binary

You probably know that option values decay over time on an exponential basis. The closer to expiration, the faster the decay, culminating on expiration day itself when the option finally settles at its intrinsic value. With little to no time value, positions become “binary.” Options either have value or they don’t.

Let’s say a trader owns 50-strike calls on a hypothetical stock (XYZ) that’s trading at 49.90. If the stock rallies a bit and closes above 50, the trader could exercise his calls and own XYZ  shares. But if the stock closes below 50, the call would expire and the trader would not own the stock.

So what to do? That trader might offer stock for sale as a short against his calls, perhaps modestly above the 50 strike price. If, for example, the stock could be sold short at 50.10 and the trader gets to exercise his 50-strike call, he’d be able to close his position with a small profit – salvaging at least some value from the call options that are rapidly decaying.

But what if dozens or hundreds of traders are looking for these same opportunities? Then the marginal additional selling just above the strike price could tend to prevent the stock from rising further. Everyone who owns 50-strike calls on XYZ near expiration could be in the same boat, trying to salvage value from a rapidly decaying asset. The greater the open interest, the more likely it is that there are plenty of offers to sell XYZ stock at or just over the strike price.

If our hypothetical trader did manage to short some XYZ stock at 50.10 and the price falls back to 49.90, then the 50-strike calls becomes worthless again. That leaves our trader with a bearish position so it might be prudent to cover that short stock position. If everyone’s still in that same boat, this tends to bid up the price of the stock back toward that 50-strike level.

So here we have some forces at work that tend to keep XYZ near 50 as expiration day trading continues. The greater the open interest at a specific strike (relative to typical volume), the more likely the stock gets pinned like this. With one big caveat. It assumes dormant volatility. But what if there are other forces at work?

The reverse pin: When volatility expands

Remember that for each option owner, there’s someone who is short that same option. Those who are short 50-strike calls on XYZ are probably happy if the stock dances around that 50 level.

But what if we have news out on XYZ that causes gap moves and wild fluctuations? The option owners sit pretty, they can trade stock up and back against their positions or simply ride out the moves. The option shorts, however, can find themselves squeezed. Short option positions have the potential for open-ended losses.

Suppose other traders had previously shorted some 50-strike calls on XYZ at a time when there was 50 cents of premium left. If the stock were to rise $3 for some reason on expiration day, then those who sold calls might not be so happy. A call option seller might cross his fingers and hope the stock goes back towards 50, but there could be a lot of pressure to cover that position.

One way to do that would be to buy stock. Short call positions lose money as a stock rises, so buying stock can alleviate some of those losses. On the margins that pushes the stock even higher, and theoretically could move it past the breaking point of the next guy fretting over his call short at perhaps the 55-strike. And so on. Multiply that by a large open interest, and you have essentially end up with a reverse pin. Open interest moves the stock away from strike price as volatility expands.

Long story short: Option owners might lose this battle, but their losses are contained to the premiums paid on the options they bought. Options shorts could win, but the potential open-ended losses can cause some considerable pain. Roll it all up, and you pretty much have a zero expectation game on expiration day. Pins do happen, but compounded moves away from strike prices happen too, although less frequently.

The options biz has evolved in a big way over the past decade. We’ve gone from monthly expiration and $5 wide strike prices to weekly options and $1 wide strikes. Obviously with strikes that are $1 apart, a stock can’t help but sit near some strike price.

That changes things, so in part 2 of this series, I’ll introduce you to pins and anti-pins in this new options world.

Important Note

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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.