Pin Risk – Key Points About Selling Options Part 12
Pin Risk – Key Points About Selling Options (Part 12)
Pin risk is really important. It only exists from the sell side. And what is it? Pink risk occurs when the stock settles close to the strike price at expiration. Pin risk, you can actually also say is the risk you have even prior to expiration of not knowing what the option holder is going to do. You don’t know if this option is going to finish ‘in the money’, ‘at the money’ or ‘out of the money’. Regardless of all of that you don’t know what the option holder is going to do with their contract, which leaves you with uncertainty on whether or not you’re going to have a stock position having to deliver shares or purchase them.
You might be okay with that. Some investors might think, well if I’m a sign I’ll take assignment and if I’m not assigned, I’m okay with that too. And then you can let this whole thing play out, but frequently the case is that the options seller would like to know what position am I going to have come say the Monday morning after expiration. I want to know what that is and if you have the stock trading right at the strike price, you have a high level of uncertainty. Now, you always have uncertainty when you sell options. I’ll say that as a general statement. When you sell an option you are, from an educational perspective, you’re never 100% sure that you’re not going to be assigned.
You certainly can feel extremely confident when the option is ‘out of the money’ that you won’t be assigned. But, there’s a level of uncertainty. That level of uncertainty increases the closer the stock is to the strike price and that may lead you to have incentive to take some action. Sellers need to be aware of this uncertainty which includes overnight risk and commit capital when necessary and the potential for even after-hours market moves.
To put numbers on this, a seller shorts the $270 put. I get this kind of example opposed to me all the time, things that just happened. Short the $270 put shares trading just above that, heading into the closing bell. This investor will tell me – hey, look I’m watching the market, its trading $270 in a quarter. $270, you know, spot three; and I’m watching it all the way through the closing bell. The underlying stayed above $270 and I was assigned, and they think something wrong happened. And they were inappropriately assigned because Monday morning this thing is trading down at $266. If they’re assigned, of course, they have to buy stock $27,000’ worth of is the cash outlay to buy those shares at the strike price of $270. And you wouldn’t want to wake up Monday morning thinking, I’m okay this thing expired 30 cents ‘out of the money’ and now all of a sudden you own a hundred shares and its trading down four or five dollars something like that. It’s not something you want to have to endure.
However, the right of the option holder has nothing to do with where the stock is versus the strike price at the closing balance expiration day. It has nothing to do with it. The option holder can exercise even if it’s not in their financial best interest to do so, and certainly prudent investors who hold options that are that close to the strike price will watch afterhours activity and see is this start to move. Undoubtedly, the cases that I get when I watch the time and sales, I’ll see. Well, yeah, it closed at the closing bell at $270 spot three, but then there was some pretty big after-hours activity. It was trading down in at the $269 handle during afterhours. And if you’re an investor holding a $270 put and you see that you’ll call your brokerage firm up and say, hey look I think I’d like to exercise my put option. I know where the stock expired, but after-hours activities going to lead that discussion. If that happens, then you can certainly be assigned on the flip side. You really want to be aware of that.
If you’re selling options and you’re evaluating the likelihood of being assigned. The only way to take that possibility off the table is to not have an assignable position. I understand the motivation of trying to squeeze every penny out of a trade. I’ve done it many, many times myself trying to get every last dime I could out of the trade. It’s just not always possible to do that without taking on an unnecessary amount of risk. The only way to avoid the possibility of an assignment that you don’t want is to buy the close and exit of the position.
Usually buyers have about 60 to 90 minutes after the closing bell to inform their brokerage firms of their exercise intentions. That timeframe can vary from one firm to the next, but that gives you some idea of just how much time the buyers have to watch the market. Watch afterhours activity and see what market conditions exist and then further make a decision irrespective of the final moneyness of the option at the closing bell. So again, our website optionseducation.org and our email address, the investor services guys are very helpful and knowledgeable option at the OCC.com. There are our social media sites. And again, if you want to go to our website to our facts section, check out our upcoming webinars highlighted by the October 23rd session with Larry McMillan that we’re really excited about. So that’s everything I had for you.