Adam Warner

2 Stocks Likely to Get 'Pinned' Down

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Tomorrow is expiration day, which means there's something on many options trader's minds: Pinning.

Pinning the strike is the tendency of a stock's price to close at or near a heavily traded option's strike price on expiration Friday.

There are two main drivers of this phenomenon.

One is the open interest of the given strike. The heavier the trading in both puts and calls at a certain strike price, the more likely the stock gets drawn, or "pinned," to that strike. This is because owners of the options will likely engage in transactions that have the net effect of forcing the stock there. Typically we're talking about call owners selling stock against their options, as the calls are set to become stock themselves.

The other driver is the general volatility backdrop in the stock itself and the market. The lower the volatility, the more likely a stock will be unable to break away from a strike price as the force from the open interest takes on greater relative importance.

As for tomorrow's expiration, we are looking at a VERY low volatility backdrop, today being the rare exception. In fact, volatility is so low right now it's likely that stocks' prices today are where they will be tomorrow. If those prices happen to be near strikes, then voila, we have a pin.

Why is it important for traders to be aware of pinning? Because of the serious risk it poses to the option writer.

Known as pin risk, if an options buyer decides to exercise an at-the-money or near-the-money option, the writer could be assigned the position. So if the writer of a call option is not covered, they will find themselves short the stock. And if they wrote a naked put, they could end up owning a stock they didn't want.

Here are two names on my radar that present some pin risk:

First Solar (FSLR)

FSLR's 10-day historical volatility is about 40, which equates to somewhere around a $3 trading range on a typical day, which is not so much that this stock won't lock around a popular strike. The issue is that there are no incredibly popular strikes.

Earlier this week, the stock was trading around $125. The combined open interest on the November 125 options is 6,000 contracts, which is very small.

Volume on Wednesday was about 6,800 contracts in the November 125 options, which suggested some new holders.

When new holders come in close to expiration, they have a pretty cheap price of entry and a pretty short leash on how far they are willing to let it run before they start hedging. In other words, they're going to trade it tightly around strike.