What is Pinning the Strike?
The phenomenon known as pinning to the strike price is fairly common among high open interest options on expiration Friday, and Alan Ellman of TheBlueCollarInvestor.com explains what it is, why it happens, and what you should do if it hits your covered call position.
When considering covered call exit strategies on- or near-expiration Friday we compare the market price of our stock to the strike price sold. If the share value is even one penny above the strike, the option will most likely be exercised and our shares sold. We may not want this to occur and we may therefore consider a rolling strategy. If the price is slightly below the strike as we approach 4:00 pm EST on expiration Friday, a phenomenon known as pinning the strike may take the price to or slightly above the strike as trades are finalized even a few minutes after 4:00 pm.
Definition and Background
There is a tendency for stocks to close very close to a strike price with a large open interest on expiration Friday. For example, if a stock is trading near the $50 strike which also has huge open interest, it will oftentimes get "pinned" @ $50 on expiration Friday. This is called "pinning the strike". This has everything to do with the Max Pain Theory,which states that the underlying security will tend to move towards the price where the greatest number of options contracts (in dollar value) will expire worthless. In other words, it is the point where option owners feel the maximum pain and option sellers capture the greatest reward.
Theories as to the Cause of Pinning