Pinning the Strike

Pinning the strike is the tendency of an underlying security's market price to close at or very near to the strike price of heavily traded options (in the same security) as the expiration time nears. This doesn't always happen, but it is most likely to occur when there is significant open interest in a particular expiring option that is near the money. For example, if a stock is trading near $50 and there is heavy trading in both puts and calls at this strike price, there is a tendency for the stock price to be "pinned" at $50 as traders unwind their positions at expiration.

Pinning the strike most often occurs in stock markets with listed options, but may happen for options with any sort of underlying. Pinning the strike happens most frequently when there is a large amount of open interest in the calls and puts of a particular strike as expiration approaches. This is because options traders become increasingly exposed to gamma as contracts approach expiration, accelerating into the hours just before the expiration date and time. Gamma is the sensitivity of an option's delta to changes in the price of the underlying. The delta, in turn, is the sensitivity of an option's price (or, premium) to changes in the price of the underlying.

As the gamma grows, small changes in the underlying security's price will create larger and larger changes to the option's delta. Options traders, who are often hedging in order to be delta neutral (directional neutral), will need to buy or sell increasingly large numbers of shares in the underlying in order to keep their risk exposure in check.

Pinning a strike imposes pin risk for options traders, where they become uncertain whether or not they should exercise their long options that have expired at the money, or very close to being at the money. This is because at the same time, they are unsure on how many of their similar short positions they will be assigned on.

For example, say XYZ stock is trading at $50.10 and there is a great deal of open interest in the 50 strike calls and puts. Say that a trader is long the calls. As the stock goes from $50.10 to $50.25, he will be exposed to an increase in deltas, and so will sell the stock at $50.25 and lower, pushing its price back toward $50. The owner of a hedged long put will also need to sell shares as the stock rises from $50.10 to $50.25 - this is because he already owns shares as a hedge against the long put, but as the stock rises, the put options' deltas decrease and so he or she has too many shares and needs to sell, again pushing its price back toward $50. Say the price drops below $50 down to $49.90. Now the call holder will have to buy shares, because he will be short too many shares from before now that the call's deltas have gotten smaller and smaller. Likewise, the put owner will have to buy shares because the put deltas would have grown larger and larger and they don't own enough stock.