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Pinning stocks at expiration

There’s an excellent site that delves into research papers to find answers for questions raised by readers (CXO Advisory Group). Recently the topic was: Stock Price Pinning at Options Expiration?

A reader asked: “Do you have any research on the phenomenon of ‘pinning’ during options expiration? The theory is that there is a Max Pain price where options sellers stand to lose the least [MDW: It’s called Max Pain because it’s supposed to cause much pain for the buyers], and that they manipulate prices towards these levels.” A search of the Social Science Research Network (SSRN) separately for “pinning” and “expiration” yields the following studies, in descending order of number of downloads:

“Stock Price Clustering on Option Expiration Dates” from August 2004: “This paper presents striking evidence that option trading changes the prices of underlying stocks. In particular, we show that on expiration dates the closing prices of stocks with listed options cluster at option strike prices. On each expiration date, the returns of optionable stocks are altered by an average of at least 16.5 basis points, which translates into aggregate market capitalization shifts on the order of $9 billion. We provide evidence that hedge re-balancing by option market-makers and stock price manipulation by firm proprietary traders contribute to the clustering.”

We cannot argue with the facts, but interpretation of those facts is another matter. Max Pain theory suggests that market makers can pin stocks to the strike. The authors of this paper suggest that is exactly what happens. Their ‘evidence’? A $100 stock moves nearer to the strike price by $0.165. That’s not pinning by any definition of which I am aware. I understand that academics do research and the discovery of that small price shift is ‘evidence’ for them. However, in the real world of trading, it’s not that significant when you consider:

  • The pinning bet must be made in advance
  • The trader must pick the correct stocks because an average of 16 basis points is not very large
  • The trader must choose the right strike price
  • The strike that is closest right now may not turn out to be the correct strike price

Thus, the evidence that ‘proves’ pinning exists does exactly the opposite. It proves that it does not happen.
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