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How Options Expiration Affects Stock Prices

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. Pin Risk "Pinning" refers to the price of an underlying stock trading closer to an actively-traded option strike price than it would absent the options activity. Imagine that today is the last trading day before expiration, and that an investor has sold 100 Google ( GOOG) put options struck at 615, meaning that she has the obligation to buy 10,000 GOOG shares from a put owner who decides to exercise their option. If GOOG closes above $615, the put options will expire worthless, allowing the trader to keep the premium received from the sale. However, if GOOG closes at $614.95, the options will likely be automatically exercised, leaving the investor long 10,000 shares at the start of trading on Monday. 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. In this example, if GOOG moves down from $615.50 to $614.90 during Friday trading, our investor might buy GOOG shares at the current market price in enough size to apply upward pressure to the stock price. Imagine, then, that the stock drifts back up to $615.20. Our trader no longer needs the just-purchased shares, since the price has moved above her strike price, so she might sell some or all of the stock position; note also that option traders who have sold short the 615 calls will have the same incentive now to sell short GOOG stock in an effort to get the stock back under the $615 level...