Pinned Stock Options
The buyer of a stock option (the "long" position) has the right, but not the obligation, to buy (via a "call" option) or sell (via a "put" option) an underlying stock at a specified price (the strike price) on or before the option's expiration date. The writer of an option (the "short" position) has the obligation to buy (from written puts) or sell (from written calls) the underlying stock at the strike price if the option closes "in-the-money" (ITM). Calls are ITM if the stock price is higher than the option strike price. Conversely, puts are ITM when the stock price is below the strike price.
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Pinning
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"Pinning" is the phenomenon observed on option expiration days in which underlying stocks tend to close right at a strike price of an option (closing "at-the-money"). This behavior is not seen on non-expiration dates nor for stocks without options. Pinning creates certain risks for both public option traders and for option market makers (OMMs)--specialist dealers who earn commissions by buying from public sellers and selling to public buyers, thus ensuring the existence of a liquid market for options.
Trader Risk
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On option expiration day, a public trader with a long position in ITM options has a choice: close out the option position before the end of the day--receiving an amount of cash per option determined by the difference between the option strike price and the current stock price--or hold the position through the close and then receive (via a call) or sell (via a put) the underlying stock from or to the OMM. The risk of holding an option that is pinned near a strike price is that it could suddenly flip from ITM to out-of-the-money at the last moment, leaving the option holder with a worthless position.
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Market Maker Risks
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OMMs in general wish to avoid holding outright positions in an option, because they do not want to undertake price risk--they make their money from commissions, not from gains and losses. Because OMMs must stand ready to buy and sell puts and calls, they prefer a neutral posture with respect to prices. This preference is what drives the mechanism of pinning on expiration day.
Mechanism of Pinning
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As the market approaches its close on expiration day, ITM call holders may sell their positions to lock in a profit. OMMs are obligated to buy these calls, but do not want to take on the price risk associated with holding the calls. Therefore, OMMs will hedge away this risk by short-selling the underlying stock into the close, thereby neutralizing price risk--the short stock position loses value as the long option position gains, protecting the OMM from price moves in a strategy known as "delta hedging." Short selling tends to depress prices by increasing supply, so stock prices that were above the strike price are pressured downward toward the strike. The reverse situation occurs for put holders when stock prices are just below the strike near expiration: If the put holders sell their options, the OMM will neutralize price movements by buying underlying stocks, resulting in upward stock price pressure. The see-saw effect of offsetting pressures is why stock prices get pinned to option strike prices at expiration.
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