Effect of interest rate on options prices - Quantitative Finance Stack Exchange

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How Options Expiration Affects Stock Prices

Trading activity in options can have a direct and measurable effect on stock prices, especially option price reacts 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.

Impact of Interest Rates When interest rates increase, the call option prices increase while the put option prices decrease. The higher the interest rates, the higher your interest income would be. This makes the call option more attractive and more expensive. For put options, the opposite holds true, that is, the higher the interest rates the lower the put option price.

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 Google GOOG - Get Report put options struck atmeaning that she has the obligation to buy 10, GOOG shares from a put owner who decides to exercise their option.

By John Summa Updated Jun 25, Whether you are planning to purchase a put or call optionit pays to know more than just the impact of a move of the underlying on your option's price. Often option prices seem to have a life of their own even when markets move as anticipated. A closer look, however, reveals that a change in implied volatility is usually the culprit. While knowing the effect volatility has on option price behavior can help cushion against losses, it can also add a nice bonus to trades that are winning.

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.

This back-and-forth action driven by the exposure of option traders causes stocks to remain close or be "pinned" to strike prices with high open interest. The effects of pin risk on stock returns have been evaluated in several academic papers.

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One study from found that the returns of stocks with listed options are affected by pin clustering, on average, by 0. Gamma Explosion Sometimes, however, the other factors influencing price movement will easily overwhelm any nascent pinning pressure.

Option Price-Volatility Relationship: Avoiding Negative Surprises

Instead, it will make more sense for them to buy back the short put options. This creates more selling pressure in the stock, since the market makers who offer those puts to our traders will hedge their own new exposure by selling short equity shares. Because the time to expiration is option price reacts short, the gamma of the options and any other near-the-money options will be very high.

How to Select the Right Strike Price Trading Options?

Gamma is the risk variable that measures how much an option's stock price sensitivity its delta will change for each point move in the underlying. High gamma means that option hedgers will need to buy and sell more shares than they otherwise would if the options in question had many weeks or months to expiration.

How Interest Rates and Volatility Affect Option Prices?

Since the hedging activity in this scenario is in the same direction as the short-term price trend, the high option gamma at expiration can exacerbate price volatility. Think of gamma as lighter fuel.

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It will not cause a fire by itself, but given the spark of a sizable move in the stock, what might be a slow burn on an ordinary day can turn, on expiration Friday, into a major conflagration. Option Expiration and Stock Investors How should stock investors adjust their portfolios and trading habits to account for the expiration-related phenomenon?

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Pinning to a nearby strike price around option expiration tends to dampen price volatility, so it is not an urgent concern for any but the shortest-term equity traders. One area where pinning might have undesired effects is in the daily performance of pairs trading strategies, e.

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The effects of gamma-exacerbated price volatility are more serious. In individual equities, when monthly expiration looms, investors can look for option strikes that have a level of open interest that 1 is much higher than other nearby strikes and 2 is worth a meaningful percentage of option price reacts value of the stock's average daily volume.

Mark Wolfinger Updated September 23, The implied volatility of an option is not constant. It moves higher and lower for a variety of reasons. Most of the time the changes are gradual. When news is pending for a given stock earnings announcement, FDA results on a drug trial, etc.

Options exposure meeting those qualifications could significantly move the underlying if traders decide to close out positions under pressure. Negative gamma near expiration can also drive the market as a whole.

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