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
1- Conspiracy theory:
This theory states that market makers use their immense firepower to manipulate share price to close at the strike so as to capture maximum profit as options expire worthless. In my view, it would take an immense conspiracy by the most powerful of institutional investors to accomplish this and then go undetected by the recently improved vision of the regulators. I give little or no credence to this point of view.
2- Dynamic hedging by institutional traders who are seeking delta-neutral trades:
Okay, we’re going to need some review of definitions here so brew up a mug of high-octane coffee…I’ll wait for you…….
Take a sip, here we go!
-
DELTA- Ratio amount that an option value will change for every $1 change in the underlying security. Call options have deltas between 0 and 1. Put options have deltas between 0 and (-) 1. For example, if a call or put option has a delta of .5, it will rise or fall $0.50 for every $1 change in the price of a stock. If a stock goes up $1, a call option will rise by $0.50 and a put option will fall by $0.50. As a call option nears expiration Friday it will approach a delta of 1.00 and a put option will approach a delta of (-) 1.00.
-
DELTA NEUTRAL- This is a portfolio consisting of positive and negative delta positions which balance out to bring the net change to zero. Institutional traders use delta neutral positions to eliminate risk from their positions.
-
GAMMA- This is the rate of change of delta with respect to a $1 change in the underlying security. It is a second generation delta, if you will.
Long calls and long puts both always have positive gamma. Short calls and short puts both always have negative gamma. Positive gamma means that the delta of long calls will become more positive and move toward +1.00 when the stock prices increase, and less positive and move toward 0.00 when the stock price declines. It means that the delta of long puts will become more negative and move toward –1.00 when the stock price falls, and less negative and move toward 0.00 when the stock price rises. The reverse is true for short gamma.
For example, the BCI March 50 call has a delta of +.45, and the BCI March 50 put has a delta of -.55, with the price of BCI at $48.00. The gamma for both the BCI March 50 call and put is .07. If BCI moves up $1.00 to $49.00, the delta of the BCI March 50 call becomes +.52 (+.45 + ($1 x .07), and the delta of the BCI March 50 put becomes -.48 (-.55 + ($1 x .07). If BCI drops $1.00 to $47.00, the delta of the BCI March 50 call becomes +.38 (+.45 + (-$1 x .07), and the delta of the BCI March 50 put becomes -.62 (-.55 + (-$1 x .07).
-
HEDGING- A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging transactions purchase opposite positions in the market in order to ensure a certain amount of gain or loss on a trade. They are used by portfolio managers and institutional investors to reduce portfolio risk and volatility or lock in profits.
Stock movement and delta
Stock movement and delta
Influence of gamma
Pin pressure comes from “gamma traders” attempting to remain delta neutral. Since gamma (rate of change of delta for every $1 change in the stock price) increases as we get closer to expiration Friday traders tend to buy and sell many more shares of stock to stay delta neutral and ensure little to no risk.
Example
- BCI Corp. is trading @ $50 per share
- The dealer (market maker) is long 100 x $50 calls which have a delta of .50 and a gamma of .14. This means that the delta will change by .14 for every $1 change in share price.
- The dealer is also long 100 x $50 puts which has a delta of (-) .50 and a gamma of .14. Once again, the delta will change by .14 for every $1 change in share price.
- The dealer is currently delta neutral: (100 calls x .50 delta) + (100 puts x (-) .50) = 0. (Take another sip!)
- If the stock moves up $1, the new delta position will be 28:
- (100 calls x .64) + (100 puts x (-) 36) = 28 (call and put delta move up by .14 )
- As a result of this $1 increase in share price, the dealer must sell 2800 shares of BCI Corp. to remain delta neutral
To roll or not to roll:
If your stock is trading just under the strike sold at we approach 4PM EST on expiration Friday and it meets the criteria for potential pinning consider rolling the call position if your decision is to keep this stock for the next contract cycle.
Conclusion
The evidence suggests that pinning is real and unique to high open interest options on expiration Friday. It is impacted by the hedging forces that are normal market forces used by institutional traders to eliminate risk from their portfolios.
Market tone:
For the past five months the economic reports have been mixed but predominantly favorable for a recovering economy. This past week was no exception:
-
Retail sales rose 0.3% in January
-
Producer and consumer prices rose 0.8% and 0.4% respectively in January although the inflation forecast remains low (1.3%-to- 1.7%)
-
Total business sales increased 1.1% in December
-
Minutes from the FOMC meeting in January noted that the US economy was “firming” but not enough to positively impact the unemployment problem
-
GDP growth forecast was increased from 3.0% -to- 3.6% to 3.4%-to- 3.9%
-
The Conference Board’s index of leading economic indicators rose 0.1% in January to extend the upward trend
-
Housing starts were up 14.6% in January but building permits declined by 10.4%
-
Overall, the Federal Reserve grew more confident in the strength of the US economy but not enough to eliminate the second round of quantitative easing as unemployment and housing have not yet arrived for the party
For the week, the S&P 500 rose 1.0% for a year-to-date return of 7.2%, including dividends.
A 200-d comparison chart of the S&P 500 and the CBOE Volatility Index (VIX) shows how the market technicals have moved from bearish to bullish and the positive nature seems to be increasing since September:
S&P 500 vs. The VIX 2-18-11
Summary:
IBD- Confirmed uptrend
BCI- Moderately bullish slightly favoring O-T-M strikes
*************************************************************
To join my mailing list and learn about premium membership:
http://www.thebluecollarinvestor.com/joinfrnds.shtml
http://www.thebluecollarinvestor.com/membership.shtml
*************************************************************
My best to all,
Option premiums:
Since we are beginning a 4-week March contract cycle and Monday is an exchange-recognized holiday our option premiums may be SLIGHTLY lower than average. In these situations I make every effort to sell my calls in the first part of the first week of the contract cycle.
Alan
Premium Members,
The weekly report for the week ending 2/18/11 has been uploaded to the Premium Site.
Best,
Barry
With all due respect to Alan, I still believe it is a conspiracy. Not only that, someone out there is out to get me AND Dirk.
I sold a Google February put spread. I sold the $620 put and bought the $610 put. Dirk sold a February call spread. He sold the $630 call and bought the $640 call. Last week the stock was hovering around $625. On Monday it hit $620.04. I decided the risk was too high and bailed out. Not a significant loss, but a loss, nonetheless. JUST AS SOON AS THEY SAW THAT THEY GOT ME TO RUN OUT OF THE WATER, THE SHARKS TURNED ON DIRK! The stock headed up towards $630, Dirk bailed, and the stock closed at $630.08. EIGHT CENTS IN THE MONEY!!!!
If it looks like a conspiracy, it acts like a conspiracy and smells like a conspiracy, then it’s probably a conspiracy. I think I will open an account under an assumed name and see if they can find me then.
Pete.
I know this may seem trivial but I’m trying to print and save the weekly lists. When you three hole punch them it clips some of the stock symbols. My system will not print with margins shifted. Can you produce the PDFs with slightly large left margins?
Frank (#4),
We’re trying to get a lot of information in the report and still make it readable. We spent a lot of time working on getting the format to allow all of the data to display with a reasonable font size. I’ll experiment with to see if we can do something.
As an aside, the key information for your decision making is in the Watch List. Looking at that part of the report, it seems that you could punch the holes and still clearly see all of the data.
I’ll see what can be done.
Barry B
Hey Owen…I mean Pete,
It’s always refreshing to start our Sundays off with a good chuckle. Perhaps we should involve Harry Markopolis in this matter!
Alan
Just trying to keep it light.
Is Harry the name Dirk will be using next week?
Harry was the Bernie Madoff whistleblower who tried to stop Bernie by reporting him to the SEC for over a decade. Perhaps he can help you and Dirk.
Premium members:
You may have noticed a couple of upgrades to this week’s report:
1- When a stock is eliminated because of the risk/reward screen (Scouter) we now give the ranking that resulted in that elimination. For example, on page 2 of this week’s report you will see in the “comments” column across from APKT: “R/R = 3″.
2- For the stocks being removed this week, we now break them down into three categories:
Running List
Other Stocks
CANSLIM Stocks
Thanks to our premium members for your valuable feedback that allows us to continually enhance the quality of ther products we provide to our members.
Alan and the BCI team
Alan,
I am a recent subscriber and have a question. Are the stocks with mixed data eligible for covered calls this month? For example, JNPR passes all screens but shows a down arrow for STO.
Thanks,
Scott
Barry,
A thought regarding Frank’s comment: Very few of the comments take up the entire width of the cell. Set up the “Comment” cells as format-cells-alignment-”wrap text”. That way you can reduce the comment column size to a width that a) allows for a left margin, and b) if the comment won’t fit, will simply automatically double the line height to make it fit.
Scott (#10),
Yes stocks with mixed technicals ARE eligible. With an uptrending chart pattern with the 20-d above the 100-d ema and price bars at or above the 20-d ema we will have whipsaws where the MACD or Stochastic oscillator may display a bearish signal. Our report red flags these equities and lets you know which indicator is bearish or neutral. Conservative investors use these signals to help determine stock and strike selection. For example, if you are considering two stocks and one has all confirming technicals and one has mixed, we opt for the former if all other criteria are similar. If we have decided on a stock with mixed technicals, we may opt for an I-T-M strike for additional protection.
Welcome to the BCI community.
Alan
Hello Owen,
I’m working on my taxes this weekend and I’m in disbelief how Vanguard has made a mess of my records. Things as simple as adding my IRA interest and div. with my taxable account on my downloads. My C.C’s and stock positions, I’ve had to redo myself and the scary thing is what a audit red flag it creates. My numbers are correct and produce more tax liability but it still looks unprofessional. I’m now with T.D. Ameritrade, hope they are better for next year.
What can you share with us on a simple method to keep our records for future recall as well as the numerous changes possible in the option world.
Any help is appreciated, Phil from MA.
Owen (#11),
A few random comments:
-I’m trying to keep the report to 4 pages. By wrapping the text, the number of pages may increase.
- I sized the comments box to allow the full mixed indicator message to be on one line. specifically…Price @ 20 EMA / MACD – ? / STO – ?. This takes up exactly the size of the comments box.
- I’m trying to keep the readability consistent by having everything for an entry on one line
– I am playing with the font sizing to save some space…more later if that is actually useful..Smaller font size will impact readability.
- The report could be printed in landscape mode and them the hole punches would be in the report title section and not impact any of the data
- Net/net, I’m trying to avoid re-formatting because it took a long time to “get it right”
I’ll explore any ideas the BCI’ers come up with…but as you know we worked the format for months before the first report was published. Alan and I started working with the formatting in June of 2009 and the first report was published in late Q1 or early Q2 2010.
Best,
Barry
Phil, you don’t have an audit red flag if the download got jumbled. Print out your monthly statements. The IRA account and regular acccounts are different and will not be mixed on the statements.
Barry, your reports are tremendous time savers and I appreciate them. I realize that you are trying to keep the pages down, but they are what they are. Unlike Frank, I simply save the .pdf file to my computer and I can pull it up, increase the size of the document for better reading, print it out, if I wish. Paper is clutter to me. I have enough of it. Thanks for the wonderful work each week.
Owen (#15),
Thank you.
Barry
Barry:
I too appreciate all your work with the weekly report. I am glad I learned the system prior to the report being available since that work gave me a good understanding of how your weekly reports are generated. But, wow, what a timesaver for me. At first I used to print it, but soon changed to just copying it to a pdf file and keeping it on a separate computer screen as I go thru the watch list. I now put the couple of hours each weekend I used to spend going thru the IBD pages to better use. All for less than 30 bucks a month.
Steve (#16),
Thank you.
Barry
Owen,
Thank you for your response and help. I have little patience for a co. like Vanguard to mess up accounting.
Just to be clear, if I have a C.C. that expires and sell another the following month against the same security, should I have two different purchase and sales? One for the first month, option only and another for the second option plus the stock, if assigned? Or is it possible to add all together, two C.C. premiums plus the stock , changing the cost basis and proceeds?
I thank you for your help. You, Alan and the rest of the team have been great for me. Before I found Alan on You Tube I used to expose about 40% of my portfolio in stocks and nervously. Now I confidently invest 90% because of I T M CC’s.
I have made far more money using Alan’s teachings in the 5 months since discovery than I will spend on BCI premium membership and dvd, book costs for the remainder of my life.
Phil from MA.
Go Phil!!!!
Barry
ARUN is one of ther stocks I like this week but noticed that it was up $4.54 on Friday after the earnings. I was thinking of using an in the money option or waiting a few days to see if the price settles. Any advice or suggestions will be appreciated.
Tom
Hello Tom,
It looks interesting, volume explosion, money flow direction very positive from blowing out the shorts. Great growth, if I can find a reasonable return for a 27 or 28 I.T.M. I will probably follow you in.
You might want to also look at AKAM also, pays about 3-4% for the month in a company that has already been beaten for a fair E.R. I think the risk/reward is favorable.
My biggest profits over the last two years are from aapl. Always at least look at this stock. The other area to keep in mind throughout this year is oil, all of mine were assigned on Friday, bad timing for me with Libya. I worked in the industry for 30 years and when going in the upward direction it usually continues, when not- run.
Good luck, Phil from MA.
Alan,
Any thoughts on setting up a forum? That way comments and topics could have a continuous thread and be searchable?
P.S. I turned my father onto to this, so we are doing it together. Always fun making money.
Phil,
Thanks for the advice. I’ll definitely check out AKAM and AAPL as well.
Tom
Preston (#23),
Thanks for your suggestion. As it is set up now the blog commentary encourages all our members to ask questions and make comments on all subjects related to covered call writing and related topics (spreads etc.). We have a growing population of new investors (I can’t believe how much it is growing!) and a valuable group of experienced investors to help one another become financially independent. As we continue to grow your suggestion will be given every consideration.
Please send your Dad a warm BCI welcome!
Alan
A call which is sold short does not become a reportable gain or loss until:
1) It expires worthless.
2) It is exercised.
3) It is bought to close by you.
Each call sale has nothing to do with ANY other transaction, unless it is exercised by the buyer. If that happens, the call proceeds get added to the stock proceeds and reported as one transaction. Additionally, if the stock holding period exceeds 1 year, you have a long term gain on the entire gain.
Example: I bought 100 shares of XYZ on 03/05/10 for $38. I sell the Mar 2011 $40 call on 02/10/11 for $3.50. The stock closes at $42 in March and gets called. I report one trade on my Schedule D: Bot date: 03/05/10 Sld date: 03/18/11. Cost: $3,800. Proceeds: $4,350. Long term capital gain: $550.
Owen,
Thank you for your help, it is appreciated. Phil
I apologize if this is redundant, but I have a question regarding the premium report. I noticed NETL was listed as green two weeks ago, yellow last week (only STO down) and then nowhere to be found this week on the WSW.
However, I do find it as white this week in the Watchlist, which being white states it meets the BCI criteria in the current week.
Why would a stock meet all the BCI criteria on the Watchlist, but not be mentioned on the WSW?
-Tony
Tony,
This is an indication that NETL has been removed from the IBD 50 list. However, it still meets ALL our other BCI fundamental, technical and common sense criteria and therefore remains on our running list in the “white” cells”. It is not uncommon for a stock found in the lower 10% of the IBD 50 list to move on and off that screen but remain on the running list which also contains many other equities not found on the IBD 50 list..
Alan
With all the global turmoil I’m leaning to entering into all in the money options today. Any thoughts are appreciated.
Amy
Hello Amy,
I’m an investor who hates losing more than winning big, so I trade a lot I.T.M. I feel we were lucky to have this hiccup after expiration Friday.
I’m a little more careful this month than normal. Last week I did a buy/write on LO, 8 contracts with an 80 strike. Yesterday a buy/write 10 more but with a 75 strike. The 75 allows you to clear about 75 cents but the reason for the trade is the dividend which we qualify for during the period. The div. is $1.30 bringing the total profit to $2.05 or 2.7% net out of pocket for the month.
Good luck, Phil from MA.
Hi Amy,
I am holding off on entering my positions until I see a settling of the market. When I do, I will also go with in-the-money strikes.
Good luck.
Tony
Hi Amy:
I entered a couple postions yesterday in gold related stocks. I went to about 70% cash last Friday, allowing lots of assignments. Now I am waiting to see what happens today and tomorrow before I trade more. I will be selling ITM and ATM strikes for March expiration. I consider myself a mostly conservative cc writer.
Steve
Phil, Tony, Steve,
Thanks for your support and suggestions. I, too, am a conservative investor and plan to wait a day or two before entering my March positions.
Thanks.
Amy
A few members have emailed me inquiries as to why we removed DE from the White cell to the pink cell areas on our premium report. This company last week showed both good and bad news. The February 16th earnings report was excellent with revenues up 27% and beating earnings expectations by 20%. Also, despite hitting a recent multi-year high of $97 the forward PE was a reasonable 16x. HOWEVER, the chart was breaking down with MACD and Stochastic oscillator showing berarish signals on high volume. We moved the stock to the pink cell because momentum was turning negative. Although we could not have predicted the huge price decline the past two days and the market reaction to global events, the stock no longer met our technical requirements. DE remains a great company and perhaps we can pick it up “on sale” when the technicals strengthen.
Alan
Take a look at OCLR. Nice chart, good fundamentals and good option returns on an inexpensive stock.
Happy investing.
Fred
Looks good Fred. Anyone know why avgo was up 7% today. Citi upgrade?
Thanks,
Amy
Amy,
Looks like AVGO had a positive earnings report today:
http://www.reuters.com/article/2011/02/23/avago-idUSL3E7DN21P20110223?feedType=RSS&feedName=technologySector&rpc=43
Barbara
Premium members:
This week’s report of top-performing ETFs has been uploaded to your premium site. New members: if you didn’t receive a direct email notifying you of this upload, please let us know and we’ll add your name to the premium mailing list.
Premium members, who have changed their email addresses and do not receive direct emails, send your updated address to:
info@thebluecollarinvestor.com
For your convenience, here is the link to login to the premium site:
http://www.thebluecollarinvestor.com/member/login.php
Alan and the BCI team
Mid contract unwind: SWKS:
This is a great example of a situation when you may elect to use this exit strategy. I originally sold the March $30 call with a cost basis of $30 . Today I closed my short position @ $6.10 and sold the stock @ $35.95 creating a debit of $0.15 ($6.10 – $5.95). With 3 weeks remaining until expiration Friday there is plenty of opportunity to use this SAME cash to generate a 2nd income stream in the SAME contract month. For example, if you consider one of the stocks highlighted in the latest premium report, ARUN, you can generate great returns with or without protection by looking at the $28 through the $32 strikes. Use the single or multiple tabs of the Ellman Calculator to run the numbers. You will find many other stocks that can still generate a very nice return using the March contracts.
Alan
Alan,
I just did the same thing with ROK. I bought back the option and sold the stock for a debit of 0.20. I’m looking at ARUN and TIBX for my new position.
Fred
Alan and Fred,
To confirm BCI methodology, you sold the initial call and cashed in on a premium. Then the call went so deep ITM, you were able to “unwind” it for little cash and use the money elsewhere? In other words, you are in a position to score a double? Just trying to understand.
(Going under the adage, a dumb question is the one not asked.)
Tony,
You are 100% correct in your analysis. Technically the term I coined, “hitting a double” refers to a situation when you sell a call, then the stock declines in value and you buy the call back for a lower amount. If the stock and option price then goes up in value, that same option can be sold on the same stock in the same contract month thereby “hitting a double”.
What Fred and I accomplished today (“mid-contract unwind”) is for a scenario when the stock price appreciates leaving the strike deep, in-the-money. A deep I-T-M strike will have little time value. As the time value approaches zero we can close our positions for very little cash and use the sale of the stock to enter a new position.
Here is a link to an article I published on this topic:
http://www.thebluecollarinvestor.com/blog/closing-covered-call-positions-mid-contract-the-elite-calculator/
Thanks for the question. As you know, there is no such thing as a “dumb” question on this site.
Alan
Alan
I’ve noticed that you often use Invest Tools. do you use their Phase 1 and Phase 2 evaluations?
Would you consider that an additional sort for the best stocks. All of the ones in the current lists have “price patterns” of 3.5 to 4 and most have decent Phase 1 & 2.
Frank,
The BCI system that I have developed over the past two decades uses fundamental, technical and common sense screens. In my view it is both accurate and time efficient. Some of our members have added or deleted some of the screens and tailored it to their specific needs and determinations. Adding the Invest Tools screens may have two drawbacks:
1- Add more time to the screening process that may not add value.
2- May decrease the pool of available stocks to choose from making it difficult to fill a large portfolio.
That being said, I do feel that Invest Tools offers a quality screening service and the fact that it gives high grades to the BCI screened stocks confirms that it is in agreement with our BCI system. Should you decide to add this screen please let us know how you make out.
Alan