A market-induced mechanism for stock pinning

Marco Avellaneda, Michael D. Lipkin

Research output: Contribution to journalArticle

Abstract

We propose a model to describe stock pinning on option expiration dates. We argue that if the open interest on a particular contract is unusually large, delta-hedging in aggregate by floor market-makers can impact the stock price and drive it to the strike price of the option. We derive a stochastic differential equation for the stock price which has a singular drift that accounts for the price-impact of delta-hedging. According to this model, the stock price has a finite probability of pinning at a strike. We calculate analytically and numerically this probability in terms of the volatility of the stock, the time-to-maturity, the open interest for the option under consideration and a 'price elasticity' constant that models price impact.

Original languageEnglish (US)
Pages (from-to)417-425
Number of pages9
JournalQuantitative Finance
Volume3
Issue number6
DOIs
StatePublished - Dec 2003

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ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)

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