There was some interest in the concept of Options Pinning strategies on various posts – so I tried an experiment with this concept last Friday, with some spectacular results. Pinning is a concept in the Option markets where Stocks, ETFs or Index Options are “pinned” down to a certain strike price, which in general also coincides with a round number – For example AAPL got pinned at 520 on Friday, GOOG got pinned at 540. The Pinning phenomenon works because big hedge funds and Prop traders have exposure at certain strike prices in the Options markets, and it is in their advantage to see expiry happen very close to these strikes. The way they achieve this is by placing large Buy / Sell orders in the Equity markets and the Futures markets. The orders are large, so these have the ability to “guide” the stock to a certain price by the end of the day. Pinning does not work every time, especially in volatile markets where lots of fundamental events or news is happening, but in the absence of such market moving events, it tends to occur more frequently.
First of all – let’s be clear. Pinning is a highly speculative strategy, with potential for very large profits, and losses as well. Secondly, you pretty much have to be on your computer every minute. A 15-minute coffee break could turn you into toast. This is because we’re dealing with Options expiration on the final day, so Delta and Gamma are going to move violently for ATM pinning strategies. Thirdly, it’s important to take a calculated measure of the market behavior that morning since the open. If things are stable for the first two hours, say until 12 noon ET, its time to think of some good stocks or indices for pinning strategies. Also, if you deploy Short Option strategies, you will need sufficient margin.
Okay, having said all this, lets take a look at what Pinning strategies can produce on a good day. Friday’s market action was highly range-bound. The SPX opened lackluster, and traded between 1465 and 1470 all day. Not surprisingly, all the major stocks behaved the same way. Around 12 noon, I decided to try a couple of pinning strategies.
After studying individual stocks and indices, I decide to try pinning strategies on GOOG, PCLN and SPX.
1) PCLN was hovering around 655 with a + or – 2 range. I put on a Short straddle at 655 for a premium of $3.55
2) GOOG traded between 735 and 740, but closer to 740. I put on a Short straddle at the 740 Strike for a premium of $4.2
3) On SPX, I put a Short strangle at 1465 / 1470 strikes.
The graph below is a snapshot at 2 pm ET.
1) GOOG started to move towards 735, and I was getting a bit nervous. I took a $465 Loss on the 740 Put and opened a 735 Short put. Then it started to move towards 740 again. 2 hours had passed since I opened the position, and time decay was working very well already. At 2 pm, I closed my GOOG shorts for a profit of $1285 on the position. (You won’t believe where GOOG ended the day at 4 pm). The max profit on this trade was $4200 if GOOG expired exactly at 740.
2) PCLN was rangebound 655 + or – $2. I kept this position open for 3 hours. At one point, it seemed like it would breach 653, at which point I had accumulated a good profit from 3 hours of time decay, so I closed this position by around 3 pm for a profit of $1820. The max profit on this trade was $3550 if PCLN expired exactly at 655.
3) The SPX moved a little more between 1465 and 1470. At one point, I converted the short strangle to a short straddle at 1470 because it had moved firmly towards that strike. But because of passage of 3 hours, I was still able to pick up a profit of $1100.
The graph below is a snapshot just after 4 pm.
GOOG closed the day at 739.99 (talk about pinning !!!)
PCLN closed at 655.25 (Pretty good pinning)
SPX closed at 1472 (Its hard to pin a large Index because its composed of 500 stocks).
Overall a great trading day with about $4000 generated from pinning strategies in a matter of 3 to 4 hours.
So the takeaways are –
1) Pinning strategies will work in the absence of market moving events or news
2) In my opinion, its best to watch the first two hours of trading to get a feel for the day’s trading
3) You must be on your computer and be prepared to adjust
4) Don’t wait for maximum profit – if you can capture 30 to 50%, take it with a smile 🙂
Would welcome your thoughts on these strategies.
I hate the risk reward ratio on all those trades. Just because they worked doesn’t make me hate them any less.
LOL. I totally agree Randall. This was only meant for educational purposes. I would not do these trades at all. There was a discussion on my Linkedin group about the merits and demerits of taking up a short straddle a couple of days before expiration. I felt if you were going to do such trades (which I have pointed out as highly speculative), then its a better idea to do it on the expiration day itself. Thanks for chiming in –
I have also done similar trades on expiration day as the returns are fantastic. I knew the risks were high as you’ve stated. Although it worked for 3 or 4 months, I got burnt eventually when the price moved unexpectedly away from a profitable position. Instantly the bid-ask spreads opened up and the trend changed all day and I was unable to get out without taking a loss. I don’t mind taking a loss as a part of trading, however it opened my eyes to the large possible loss that would have occurred had there been a larger move (price shock) against me. Although I haven’t tried it, you may be able to use a spread to reduce the risk, although I suspect the risk-return would still not be worth it for expiry day as you have to use so many contracts to make a profit.
Consequently I would not recommend this strategy to any traders… thanks for the interesting article though.
David, you’re right – putting a spread really doesn’t make it worth it. I would not recommend these trades to anybody either. But if all the conditions are right (stability, no news, no events etc – what we’d call a boring Friday), then these strategies could produce some great returns. But certainly belongs in the highly speculative category.. Thanks
Apart from the acelerated time decay, there is a volatility collapse in all the strikes that are out of the money, even if just one or two strikes out of the money.
I am not sure, but I think Jeff Augen pointed this volatility collapse is usually produced in the early afternoon time.
Best regards
Miguel sure. I think it does come down early afternoon. Even in my examples, you can see it collapsed between 12 noon and 3 pm/