Keep your biases in check and avoid making predictions. First time in a while to have more new lows than highs.

In order to outperform you have to avoid the big losses that occur when selling accelerates. Consider this bearishly biased, August put spread.

Options Expiration Explained | The Options & Futures Guide

NEW YORK RealMoney -- Even if you have never traded a put or call, it is important to understand how options expiration can affect stock prices. Trading activity in options can have a direct and measurable effect on stock prices, especially on the last trading day before expiration.

Let's look at two ways that options expiration can influence the overall market as well as specific equities, and then consider how investors should deal with these tendencies. Imagine that today is the last trading day before expiration, and that an investor has sold Google GOOG put options struck at , meaning that she has the obligation to buy 10, GOOG shares from a put owner who decides to exercise their option.

Many investors don't wish to run the risk of the stock gapping down at the Monday open, so they enter stock positions designed to keep the stock price away from the short strike of their options -- this is particularly true for investors and firms with large option positions relative to the trading volume in a stock. The effects of pin risk on stock returns have been evaluated in several academic papers.

One study from found that the returns of stocks with listed options are affected by pin clustering, on average, by 0. Gamma Explosion Sometimes, however, the other factors influencing price movement will easily overwhelm any nascent pinning pressure.

Stock Option Expiration Date - Dogpile Web Search

Instead, it will make more sense for them to buy back the short put options. This creates more selling pressure in the stock, since the market makers who offer those puts to our traders will hedge their own new exposure by selling short equity shares. Because the time to expiration is so short, the gamma of the options and any other near-the-money options will be very high. Gamma is the risk variable that measures how much an option's stock price sensitivity its delta will change for each point move in the underlying.

High gamma means that option hedgers will need to buy and sell more shares than they otherwise would if the options in question had many weeks or months to expiration. Since the hedging activity in this scenario is in the same direction as the short-term price trend, the high option gamma at expiration can exacerbate price volatility.

Think of gamma as lighter fuel.

It will not cause a fire by itself, but given the spark of a sizable move in the stock, what might be a slow burn on an ordinary day can turn, on expiration Friday, into a major conflagration. Pinning to a nearby strike price around option expiration tends to dampen price volatility, so it is not an urgent concern for any but the shortest-term equity traders.

One area where pinning might have undesired effects is in the daily performance of pairs trading strategies, e. The effects of gamma-exacerbated price volatility are more serious. In individual equities, when monthly expiration looms, investors can look for option strikes that have a level of open interest that 1 is much higher than other nearby strikes and 2 is worth a meaningful percentage of the value of the stock's average daily volume.

Options exposure meeting those qualifications could significantly move the underlying if traders decide to close out positions under pressure. Negative gamma near expiration can also drive the market as a whole.

In recent years, the Federal Reserve has announced surprise interest rate cuts on expiration Fridays in a less than opaque attempt to let the cuts have the maximum possible immediate effect. The best way to accommodate the possibility of expiration-induced price swings is to be ready for more volatility by trading smaller position sizes and setting wider stops. Particularly on an intraday level, a volatile Friday morning is likely to beget a volatile Friday afternoon.

Finally, an unexpected consequence of this look into the effects of expiration on stock returns is that not all market action turns out to be as meaningful as we might want it to be.

Market participants love to assign causality and meaning to day-to-day stock returns, sometimes linking the same piece of news to up and down subsequent days. The truth is that much market action is either systemic or inscrutable. In the case of a particularly quiet day of trading near options expiration, what looks like a passive market may be in part attributable to pinning.

A wild day of trading, conversely, may not be purely about panicked, earnest investors, but also about the rational unwinding and resolving of prior option commitments. At the time of publication, Jared Woodard held positions in SPX, SPY, and QQQ. Action Alerts PLUS is a registered trademark of TheStreet, Inc. You are using an outdated browser.

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How Options Expiration Affects Stock Prices - TheStreet

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