A Trader's Guide to Expiration Week

Options activity can influence breakouts and breakdowns, but it rarely causes a legitimate change in trend. Typically, you'll see stocks at new highs fade badly going into options Friday, but then recover as the new week begins. In fact, that's a tradable phenomenon.

Can market forces overcome expiration influences?

Of course they can, but it's always the lower odds outcome. The best analogy for this dynamic comes from Superman lore. Avid comic readers will recall the time that the Man of Steel had to face the paradox of an irresistible force running into an immovable object. It's that hard to overcome the stubborn power of options unwinding.

But the market can break above or below magnetic strike numbers when enough force is applied to the system. How much force is "enough?" There isn't a good answer, but it does require a paradigm shift that shakes up the status quo and alters popular perception.

Why is price magnetically attracted to a particular level during expiration week?

Stock and index prices approach key numbers and stick to them during expiration. The principle of maximum pain explains this attraction. It states that most traders who buy and hold options contracts until they expire will lose money.

Round numbers near current levels usually hold the most open interest for that month. So stocks tend to move toward these prices in order to fulfill their maximum pain destiny. Although price often moves down to magnet numbers, there's no reason it can't move up to them as well.

BCA Software has even trademarked the term Max-Pain and features an area on its Web site where you can calculate Max-Pain numbers on a basket of liquid stocks.

Can you explain the four instruments that are part of quadruple-witching?

Quadruple-witching refers to the day on which four quarterly options contracts expire. It used to be called triple-witching, but the name was updated with the introduction of single stock futures in 2002.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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