With options expiring every week, the possibility that your underlying will be close to the strike price on the day your contracts expire is something you should take into account. These cases are famously called “pin risk options.” This article will tell you more about what pin risk is and how to use a logical approach to deal with it.
Key takeaways
- Pin risk is the risk associated with options expiring near the strike price, causing uncertainty over assignment
- This risk can leave options traders with unhedged positions over the weekend, making them vulnerable to market movements.
- Looking at open interest in calls and puts at a specific strike price can help identify potential pin risk and help you make more informed trading decisions.
What is Pin Risk?
As options approach expiration, sometimes you just can’t afford to ignore how to manage pin risk. Pin risk occurs when options expire close to their strike price, which creates uncertainty regarding whether the options will be assigned.
Take a practical case: if the market price of your underlying stock is $50.01 and the strike price is $50, it makes a significant difference compared to a closing price of $49.99. Options that are in-the-money (ITM) by even one cent will automatically be exercised, potentially leading to unexpected obligations over the weekend. This is particularly risky if you have a protective position that you didn’t exercise, assuming it wouldn’t be necessary. This is basically your “risk” on these occasions.
Now, keep in mind that the dynamics of supply and demand in the options market can drive the underlying asset’s price toward a strike price where there is significant open interest, meaning that the price at which the stock will close on the day weekly options expire is not just a random one.
Investors holding large positions may attempt to move the price to favor their positions as expiration approaches. This is often referred to as “pinning” the stock to a specific strike price. The intersection and conflict between call and put options, and buyers and sellers, at this strike point is where we typically see pin risk materialize.
For option holders, the primary concern is deciding whether to exercise their options. Failing to accurately predict the market’s direction can lead to substantial financial losses. On the other hand, option sellers face the challenge of unexpected assignments. Without knowing whether they will need to fulfill the obligations of their written options, it becomes difficult to hedge effectively. This uncertainty can leave sellers exposed to significant market risk if prices move sharply in an unfavorable direction.
Is there anything you can do to handle this risk? Well, we mentioned the open interest “magnet” effect (you will notice that prices will be attracted by high open-interest price thresholds on the day options expire), so you’re not exactly hopeless against pin risk. We have a helpful report feature that, coupled with our options screener, can help you. We’ll tell you more explain below.
What Can You Do When You Face Pin Risk?
As trivial as it may be, the easiest way to get rid of pin risk options is by closing positions before expiration. A nice tool for traders is the Open Interest report available on our website. This report can give you more information about pin risk, especially if a stock is dangerously near a strike price with high open interest as options expire. Here is what the report will look like:
For instance, let’s say you notice high open interest at the $190 price for an AMZN call the day before it expires. This would signal that many traders might try to push the stock towards this level. Note that this is not a guaranteed outcome, but simply a reminder that markets have a foreseeable and rational tendency in most cases. Therefore, pin risk is not impossible to manage, it just requires a calm, prudent approach.
Whether you trust open interest or just your instinct, it’s always better to close your positions before expiration if you are not comfortable with the potential outcomes of pin risk.
