Microsoft Rally Creates Expiration Crunch

Call sellers are on the wrong side of the rally today.
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Will

Microsoft

(MSFT) - Get Report

get "pinned" at a nice even price at the close today?

At least one veteran options trader says it won't, especially after a rally today helped it blow through 95. At midday, Mister Softee's shares were up 3 3/8 to 97 3/4.

This month, among the most widely held equity options were calls in Microsoft's July 95 and July 100 strike price. On expiration day, the massive open interest at certain strike prices will serve as a magnet as market makers and professionals adjust their positions.

The strikes with the deepest open interest, or the positions opened in the option, are the touchstones for stocks to get pinned to certain prices.

Among Microsoft's July options, open interest was heavy at the 95 and 100 levels, as each strike price had open interest over 28,000 contracts.

Earlier in July, options traders probably didn't bet that Microsoft stock was going to go on a tear. So they sold, or "wrote," thousands of calls to investors who wanted the right to buy stock at 95.

Those call-buyers hit payday Friday. They now will have to have the stock at 95 or close out their options positions at juicy profits. Sellers of the calls have to deliver it, but unless they were sitting on enough shares to fulfill their obligations, they'll have to pay today's higher prices. Their other alternative is to buy the options back at the inflated levels.

Both factors can bring about a kind of options short squeeze where simply the need to cover propels the stock higher.

Microsoft stock price banked up

again

after a report that the software giant is close to creating a stock to track its Microsoft Network properties Internet unit.

"When a stock gets pinned around a certain strike price, you have people desperately trying to sell their options out at the end of the day for 1/16, trying to do

something

to sell out. Others are trying to turn around and get out of the calls they wrote or salvage some value" out of the options, said Joe Pach, formerly a floor trader of Microsoft options on the

Pacific Stock Exchange

, now upstairs above the fray with a hedge fund. (Essentially, he's talking about those already hosed by having to deliver the stock at above 95.)

Asked to take a bet on Microsoft coming back down by day's end and getting pinned at 95, Pach says, "No, not in the July 95s. There's far too much momentum. We've broken through from a technical standpoint."

Microsoft July 95 calls were trading at roughly 1 3/4 ($175) per contract on Thursday; by Friday morning, they had shot up to 2 11/16 ($268.75). July 95 puts, meanwhile, faded away nearly to nothing, dumping 1 1/16 ($106.25) to 1/16 ($6.25) per contract.

Speaking of index options, expiration traders buy and sell index calls and puts in an attempt to make a lot of money in one session.

"We've seen a lot of call-buying lately" contributing to the firm's proprietary, in-house put/call ratio, said Kevin Murphy, options strategist for

Salomon Smith Barney

in New York. "Couple that with a low

VIX

" -- the

Chicago Board Options Exchange's

volatility index, the market's fear gauge -- "and we have been very cautious." Low fear levels makes contrarian options pros worry that investors' comfort levels are too high, and therefore bullishness translates into bearishness.

Murphy also repeated Solly's house argument by technical strategists that they are more cautious on Internet stocks.

TheStreet.com Internet Sector

index, or the

DOT

, was down 1.24% to 641.67.