Guide To Gold Pin Risk
Courtesy of www. fmxconnect.com
All About Pin Risk
Today is July options expiration in silver and gold. We’d like to take this opportunity to go over some of the basics and correct some misconceptions on pin risk and what it entails.
#1 Pin risk is not about direction manipulation, it is about volatility management (or manipulation if you prefer).
#2 Pin risk is classic weak hands vs. strong hands trading or described differently, trading where the deeper your pockets, the more likely you are to be the winner.
#3 Pin risk starts with a simple premise, it’s about long options players versus short options players. Its not about bulls vs. bears.
#4 The more money you have the less likely you are to be long options. The less money you have the less likely you are to be naked short options. Subpoint: people with money don’t buy insurance, they sell it. People who cannot bear catastrophic risk or must manage their bankroll are net buyers of options.
#5 Options buyers almost always have less capital then option sellers. This is because they must limit their risk to participate in a market (can’t afford to have infinite risk) like an options seller can.
Starting with the fact that buyers of options almost always have less money than sellers of options, its easy to see how this is played out. But first it may be helpful to explain why direction doesn't matter.
Most professional traders, i.e. bank dealers, proprietary trading firms and principle market makers hedge their directional risk. Longs of options want the market to move away from the option they bought in either direction. Shorts want the market to move toward the strike that they sold.
Longs make money though gamma scalping. Gamma trading allows them to buy low and sell high in the underlying market without risk of adverse movement. Conversely, the disciplined short option player should sell high and buy low hoping that the market movements will cost him less money than the premium he collected from selling the options. But if the short option player is a single bank with a 1 billion dollar balance sheet and can leverage itself up to 40 times he may not be so disciplined. He may instead be encouraged to play the “bully” game, and attempt to pin the strike. He may do this by selling high (adding to his position) and buying low in an attempt to manage volatility for the brief period of time before expiration. Meanwhile the longs are almost always a fragmented community of smaller firms and independent traders using their visa cards to trade. They don’t have the capital or leverage and usually are a fragmented group. Their disciplined trading of selling high and buying low contributes to the gravitational pull of the strike. The shorts who should be counterbalancing those trades by buying high and selling low are actually buying high and selling low.
This goes on all the time but to be clear I do not feel that big market players can force a market close to a strike. They can however facilitate pinning if the market is already there. In a sense pushing the weak players over the cliff when they have already put themselves on the edge. It is manipulation.
I realize this is a lot to say in a short article but we will be writing an in-depth report on pin risk and how expirations and how expirations affects price movement in the coming week. For now, know that in my experience as a market options market for 20 years, that when a single bank is short a straddle and 450 guys like me are long it we’re probably going to pin the strike. The times that strikes do not get pinned are when the longs are in the hands of a strong small pool of speculators who are actually directionally biased. This is rare. Examples of longs who have run in the banks are when Fibro in silver in 1995 or when JPM pushed the silver market in 2008. There are many other instances but it really comes down to this. How much money do you have and how concentrated is the open interest?
For today, the strikes that matter are the July 1200 and 1250 strikes. The 1200 strike has more open interest but we are closer to 1250. Your guess is as good as mine if the graviton pull of either strike will attract the futures today. For those who care, options officially expire at 4PM on the comex which means if you have open interest you have the time between when the market closes and options expire to decide whether to exercise or not. On the flip side, you don’t need the market to pin the strike when comex closes. You need the market to be pinning the strike in the afterhours when the underlying is more thinly traded.