Expiration Friday is a busy day in the options world. It is the last day to trade many contracts and volume picks up, as options players close out or adjust their positions. If options are left open into the expiration, the contracts will either expire worthless or they will be exercised, depending on whether the contract is in-the-money or out-of-the-money. There are certain situations, however, when an options contract is exactly at-the-money at expiration. When it happens, this so-called pinning can be a source of frustration, and opportunities, for options traders.
If a stock settles at a value equal to the strike price of an expiring option at the close of business Friday before expiration, it has pinned to the strike price of the options contract. The contract is exactly at-the-money, or ATM, (the stock price equals the strike price). At that point, there isn't much the strategist can do. The contract has no intrinsic value and no time value. It is worthless.
Out-of-the-money, or OTM, options expire worthless as well. For example, if I hold Potash of Saskatchewan (POT) October 150 calls and the stock settles at $145.00 today, the contract will expire worthless tomorrow morning. There is no reason for the call owner to exercise the contract and call the stock at $150.00 because shares can be bought in the market at $145.00.
The Options Clearing Corporation, or OCC, automatically exercises any option contract that is in-the-money, or ITM. If the contract is even $0.01 ITM, it is eligible for automatic exercise by OCC rules. So, unless you instruct your broker otherwise, you can expect to have ITM options automatically exercised at expiration.
Pinning can affect whether or not we close or adjust positions. Let's consider an example. The OptionsXpress options chain shows Potash shares trading at $145.02 and heavy trading in 145 puts and calls. If the stock settles at $145.00, both contracts will expire worthless. What if it doesn't?
Potash of Saskatchewan (POT) Pricing
If POT settles at $144.95, the October 145 puts are $0.05 ITM and will be automatically exercised. If you sold one of those puts, you are going to find 100 shares of Potash shares in your account Monday morning. The puts have been exercised and the stock has been put to you. The cost is $145 X 100 or $14,500. If you don't want to buy the stock, then you will need to buy back those puts before the close of trading Friday. But, if the stock is getting pinned, you might face a real dilemma as you watch the stock trading around the strike price of those puts heading into the closing bell.
Pinning can create additional headaches for spread traders, but create opportunities as well. For example, let's say that I've opened an October - January 145 call spread on POT. The October options are about to expire and I want to roll to November. If shares are getting pinned to the strike, I won't know whether to buy back the October calls and sell November, or simply let the October options expire and then sell November. If I hold the position through the expiration and get assigned, I will be asked to sell 100 shares of stock at $145.00 and that, in turn, will force me out of my calendar spread.
On the other hand, if a stock appears to be pinning into the expiration, some investors might try to profit from it. For example, one might sell a straddle (puts and calls) into the expiration. In POT late this Friday, we can see the October 145 straddle is trading at $0.60. What if I sell the straddle and the stock is pinned to $145.00 at expiration? Both puts and calls expire worthless and I keep the $0.60.
Pin risk is a fact of life in the options world. If you hold ATM options into the expiration, there is a chance shares will gravitate towards the strike price of the option. You might face a dilemma heading into the expiration. In many cases, it is simply better to close out the position rather than face the risk of assignment because there are situations when an option holder would exercise an ATM or even slightly OTM option. There are other situations when a stock might move in the after hours market and, at that point, it will be too late to close the position and avoid assignment on ITM options.
At the time of publication, Fred Ruffy held no positions in the stocks or issues mentioned.
Frederic Ruffy is an experienced trader and provides daily commentary and analysis of the options market. He is co-founder of the web site, WhatsTrading.com. His work has also appeared in Futures Magazine, Technical Analysis of Stocks & Commodities, Stock Futures and Options, and Sentiment. OptionsProfits For actionable options trade ideas from a team of experts, visit TheStreet's OptionsProfits now.
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