On of my favorite plays on the Friday of expiration is the open interest play. The theory is that the bigger the open interest at a certain strike, the more likely the stock will tend to go to that level.
The reason for the open interest play is because of “pinning”. What is “pinning”? Pinning is when a stock closes on expiration Friday exactly at its strike price. Because of the risk of the stock moving either after the close, or on the following Monday, sometimes options are assigned and sometimes they are not. The risk of having a position that is totally unhedged is a big risk for most traders.
As the stocks gravitates towards the strike, traders decide to cash out and flatten positions. This becomes a self fulfilling prophecy, as now the stock has even more of a tendency to move closer to the strike.
This used to work MUCH better in the old days. Many floor traders, like me, would do a trade called a conversion. This is a risk free position where I would buy the stock, buy the puts, and sell the calls. This way, in the days where you had to short on an uptick, I would have long stock to pound out if the market was suddenly plunging. On expiration day, if I worried about pinning, I would have to start selling the stock, buying the calls and selling the puts, so I wouldn’t have to worry about an unexpected assignment. Because so many traders did the same thing “pinning” plays were occurring all the time.
Now, with all sorts of hedging that could make the trading in the calls totally unrelated to the trading in the puts, huge open interest can still be “gamed,” but it has to be combined with charting, and companion stocks.
Here is my scan for open interest. I like stocks over 20 dollars per share, but this is just a personal preference. I like to look for stocks where the average daily volume is below 15 million shares, and the open interest is at least 8000. The bigger the volume of the stock, the less likely that open interest will affect the price of the stock. I also like only options that are within the expected daily move in the underlying stock. I have found just putting in an option price between .15 and 1.50 works really well.
After these stocks are found, I like to chart each one. I also like to have a feel for the overall market. A plunging market, and I will look for stocks ABOVE their big open interest, as possible shorts.
This morning I noticed the huge open interest at 100 for $PEP. $PEP is considered a “safety” stock, so if the market plunges on the opening, traders usually flock to stocks like $PEP and $KO. I will then chart $PEP with $KO. Usually they correlate well.
Next I will look at short term charts of both. The reversal in $KO made me more confident the reversal of $PEP would hold up. Once $PEP got over 99, with a reversal candle, the big open interest acted as a “magnet” to pull it towards 100.