It’s Friday afternoon, and all over town, people are getting ready to kick off their weekend. Some folks are making dinner plans, some are getting all gussied up for a night at the club, and some, like us, are feverishly watching the price of our favorite securities as the markets get closer to closing.
Why so feverish? Because we’re looking for a phenomenon called “pinning the strike,” which is when the closing price of a security is really, really close to its strike price. This tends to happen when there’s a lot of open interest in the stock’s near-the-money options that are about to expire.
Let’s say a grocery chain called Food for Bellies, Inc.’s stock is trading at about $41.25 per share. Now let’s say there are a bunch of $41 puts and calls out there that are about to expire. As we get closer to market closing time, all those option holders are watching Food for Bellies’s stock price, trying to figure out if they need to buy or sell before that closing bell rings and their options expire. Depending on whether they’re long or short, and whether we’re talking puts or calls, they’re going to buy and/or sell in an effort to keep that strike price close to the actual stock price. In other words, they’re pinning the strike price to the stock price. These guys are also really good at pinning tails to donkeys.
Related or Semi-related Video
Finance: What Is a Put Option?83 Views
finance a la shmoop what is a put option? hot potato hot potato
ow ow! yeah remember that game well nobody wanted the potato, poor thing. the
players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]
of work the same way. a put option is the right or option or choice to sell a
stock or a bond at a given price to someone by a certain end date.
all right example time. you bought netflix stock at the IPO a zillion years
ago at $1 a share. that's you know splits adjusted. all right now it's a hundred
bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in
California that would be a tax of something like almost 40 bucks. well the
stock was a hundred but you keep only something like 60. feels totally unfair.
right so you really don't want to sell your stock but you're nervous about the [graph shown]
next few months that Netflix will crater for a while and go down ten
maybe twenty dollars. longer term though you think it'll hit 300. so this is the
perfect setup to maybe look at buying some put options on Netflix. if the stock
goes down your put options go up. with Netflix volatile but at a hundred bucks
a share ,you look up the price of an $80 strike price put option expiring in
December, and you know that's mid-september now .for five bucks a share
you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]
term life insurance. you pay the five dollars a share in the stock goes down
to 82 by mid December, worst of all worlds. well not only did you lose the $5
a share but your stock has lost $18 in value. but had Netflix really cratered
and gone to say $60 a share well you would have exercised your put and sold
your shares at 80 bucks. well those put options you paid $5 for
would be been worth 15 bucks a share. in buying that put option you've [equation shown]
guaranteed that your loss will be no more than a $75 value for your Netflix
position at least for that time period and ignoring taxes. well remember that
options expire after December whatever like the third Friday of the month it's
usually when options expire, you then have no protection and your shares float
along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]
raunchy. yeah well that's naked put options.
that's what they really are people.
Up Next
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
What is a strike price? Strike prices are used in conjunction with options. Calls and puts give investors the right to buy or sell stocks at predet...