A market-induced mechanism for stock pinning

Marco Avellaneda and Michael Lipkin

Quantitative Finance, 2003, vol. 3, issue 6, 417-425

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.

Date: 2003
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DOI: 10.1088/1469-7688/3/6/301

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