Pin risk is a concept in options trading. It describes the uncertainty when an asset’s price is at or near the option’s strike price at expiration. This situation is called "pinning." It creates ambiguity for both option holders and writers. They are unsure if the options will be exercised or assigned. This uncertainty can lead to unintended financial exposure.
If an option is slightly in the money, it may be exercised. The seller must deliver or take possession of the underlying asset. If it is slightly out of the money, it may expire worthless. The holder might miss out on potential profits.
The underlying asset may move significantly after the market closes. This movement affects whether an option should be exercised. Most options settle based on the closing price. Traders may face unwanted risks.
Option holders must decide whether to exercise their contracts. Sellers may not know if their positions will be assigned until the next trading session. This uncertainty can cause gaps in portfolio hedging. It can lead to unexpected financial outcomes.
Consider a trader holding call options with a strike price of $50. The stock closes at $50.01 on expiration day. If the trader does not exercise the call option, they may miss the chance to profit from the slight in-the-money value.
Additionally, if the stock price drops in after-hours trading, the trader could be assigned the stock at an unfavorable price. The option writer faces uncertainty about whether they will have to deliver shares. This impacts their hedging strategies.
Traders and market makers can mitigate pin risk through different strategies.
Closing options positions before expiration helps avoid last-minute decisions that cause pin risk. Rolling options to later expiration dates maintains control over exposure.
Adjusting positions in the underlying asset can neutralize the potential impact of the assignment. Delta hedging involves continuously monitoring and adjusting the hedge as the asset's price changes.
Monitoring post-market movements allows traders to anticipate potential assignment outcomes. They can adjust their strategies accordingly.
Pin risk is especially significant for institutional traders and market makers. They handle large positions. Unexpected assignments can lead to liquidity issues.
They may have margin requirements and additional trading costs. Effective management of pin risk is essential. It maintains portfolio stability and avoids unintended financial exposure.