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Trading Stocks Using Option Open Interest

|Includes: Apple Inc. (AAPL), GOOG

If you are ever planning on paying attention to options trading or options open interest tomorrow is your day. January options expiration is one of the biggest stock options trading days of the year. January is different then most months because it trades 2 years in advance. This means the options expiring tomorrow have been active since 2011. Most options are only available 3 to 6 months in advance. This gives January options more time than normal to accure and build open interest, leading to very high open interest. Open interest is defined as the number of options not closed at the end of the trading day or the number of outstanding option contracts in any given strike.

Why is this significant? On expiration, stocks tend to "pin" at strike prices. To pin means that when options expire (3rd Friday of every month) the stock is trading either at or near the strike price. Take for example an options trader in Apple (NASDAQ:AAPL). This trader has sold 50 AAPL Put options struck at $500. This trader now has the obligation to receive 5,000 AAPL shares if the stock closes below $500 and the Put option owner decides to exercise. If AAPL closes above $500, the trader is in the clear because the options expired worthless. He collects his premium and has a nice profit. However, if AAPL closes below $500 the trader will most likely be exercised on his Puts and would be long 5,000 shares at the open of the next trading day. This gives a trader incentive to keep the shares above $500. If AAPL drops to $498, the trader may be inclined to buy a large block of shares to move the market back up above $500. Let's say that due to the traders large stock purchase the stock is now trading at $502. Great, right? Our traders Puts are now out of the money and he has no risk of being exercised on them, but now he is long the stock - which he no longer needs! So what does our trader do? He sells his shares which pushes the stock back near or below $500. So in theory, large open interest in at-the-money options creates sellers of stock above the strike price and buyers below the strike price. It is now easy to see why stocks tend to pin at strikes on expiration. Keep in mind this type of trading is done mostly by large, institutional option traders.

Since tomorrow is the most active expiration of the year, lets take a look at which strikes have large open interest. Below is a list of high option volume stocks. It lists the open interest and how close the stock price is to pinning to a strike.

Options Open Interest and Pin Risk Expiration

By looking at this data we can see these active stocks are well within strike range, most less than 2%.

How will this help me trade stocks? Knowing that stocks will tend to pin to a strike can help you gain a trading edge. Tomorrow Google (NASDAQ:GOOG) theoretically should pin at $700.00. It is currently trading at $711.32. Therefore you can be sure with some certainty that GOOG has an expected move of -$11.00, to reach $700.00. By using the expected move row in the above image you can get an idea of where stocks are headed tomorrow.