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A market-induced mechanism for stock pinning

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  • Marco Avellaneda
  • Michael Lipkin
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    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.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

    Volume (Year): 3 (2003)
    Issue (Month): 6 ()
    Pages: 417-425

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    Handle: RePEc:taf:quantf:v:3:y:2003:i:6:p:417-425

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    Cited by:
    1. Benjamin Golez & Jens Carsten Jackwerth, 2010. "Pinning in the S&P 500 Futures," Working Paper Series of the Department of Economics, University of Konstanz 2010-12, Department of Economics, University of Konstanz.
    2. Stivers, Chris & Sun, Licheng, 2013. "Returns and option activity over the option-expiration week for S&P 100 stocks," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4226-4240.
    3. Jeannin, M. & Iori, G. & Samuel, D., 2006. "Modeling stock pinning," Working Papers 06/04, Department of Economics, City University London.
    4. Suhas Nayak, 2007. "An Equilibrium-Based Model Of Stock-Pinning," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(03), pages 535-555.
    5. Xiaoyan Ni, Sophie & Pearson, Neil D. & Poteshman, Allen M., 2005. "Stock price clustering on option expiration dates," Journal of Financial Economics, Elsevier, vol. 78(1), pages 49-87, October.

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