The following question from a professor of computer science is on a subject that generates much controversy in the options universe. There are believers and non-believers and neither group has the ability to convince the other.
I'd appreciate it if you comment on this. David Fry writes that on expiration day "… I fully expect some serious gyrations as those on the floor will hunt down strike prices like heat-seeking missiles." This was from his commentary last month the day before expiration. Do you agree, and if so, would you explain what the floor traders are looking for. That is, do they tend to push options that are slightly out of the money into the money at the last minute?Thanks.
California State University, Los Angeles
You ask: what they are attempting to accomplish? The theory is that traders who sold (thus, are short) calls and/or puts want the stock to close for the day exactly at the strike price. That's referred to as 'pinning the stock to the strike.' The goal is for those options to expire worthless, or as near to worthless as possible.
Some people believe it's an easy matter to 'pin' a stock to a strike price. Others believe it's an impossibility due to the huge number of shares that trade daily. This is a topic about which there never may be complete agreement.
I belong to the group that believes pinning a stock is so difficult to accomplish that it is essentially impossible. To me, no individual, or group acting in collusion (which is against the law) can buy or sell enough stock to push a stock's price so that it finishes at the strike price (or any other specific price). Why? Two major reasons:
First, it requires buying or selling a large number of shares – in fact, to prevent the stock from moving through the strike price, you would be forced to sell stock to buyer (or buy from all sellers) to prevent the stock stock from moving higher (or lower) through the strike price.
With no good way to hedge those trades, the risk would be enormous. To get a proper hedge, you must buy many call options. Whoever sells those calls is going to be bidding for stock to hedge their call sale. You also want to sell a large quantity of puts – and guess what? Those put buyers also want to buy stock to hedge their put purchases. Thus, even if you can trade some options to hedge your stock sales, you are adding to the buying interest in the stock. It's a self-defeating strategy that involves enormous risk (because the seller would have to hold that short stock position until the markets reopen next Monday).
Second, if any buyers or sellers of 'size' are lurking – and there are plenty of them these days as trading has been very active during the final half-hour of the day – the size buyer/seller would easily overwhelm the group trying to manipulate the market.
How would you like to find yourself selling a few hundred thousand shares at 49.99 and 50.00 (to prevent the 50 calls from moving into the money), only to find that there was a secret buyer of two million shares? When that buyer makes himself known, the stock could easily move a point or two higher. You would not only be short 200,000 shares (at a loss of 200 to 400k), but those calls you had hoped would expire worthless are also ITM. It's just too risky. In today's marketplace, market makers are very risk averse and try to be well-hedged all the time.