A High Win Probability Binary Options Strategy

Traditional options expiration presents an opportunity for binary options traders to implement a high probability strategy designed to take advantage of patterned stock movement during the last few trading hours on options expiration Friday.  Pin risk is often attributed as the reason why certain highly traded; optionable stocks behave the way they do on expiration Friday.

What is “Pin Risk”? Pin risk is typically defined as “the risk that the underlying asset of a traditional option will close near the strike price at expiration. In these situations, the option seller does not know and cannot predict whether or not the option holder will exercise the option. The seller must then decide whether or not to cover the position by taking an equal but opposite position in the underlying asset. If the seller covers the position and the option is not exercised, he/she may be forced to hold securities that will result in a loss. Likewise, if the seller does not cover the position and the option is exercised, he/she must rush to fulfill the contract, which may also result in a loss.”

Why is this important? To avoid the risk of pinning, institutions, which are usually short options, trade stock around their options positions, which tends to move stocks towards strike prices with heavy open interest at expiration. This presents a nice opportunity for binary options traders to place high probability trades on stocks moving towards its pin strike.

How does this work? The best way to demonstrate this “Pin Risk” effect is to look at stock price movement of a couple of highly traded, high open interest optionable stocks heading into options expiration. In the chart below we highlight 3:00-4:00 pm EST price data for Google (GOOG) and Citigroup (C )on Friday June 18, 2010 (June options expiration).

Pin Risk Chart

As you can see in the chart, stock price moved towards the nearest high open-interest strike. A smart binary options trader would have recognized this potential pinning situation and would have been able to purchase the appropriate call to generate maximum profit at 3:00. While this strategy is not 100% guaranteed to work (no strategy is!), the vast amount of academic research underlying the “pinning” premise supports the high probability nature of these trends.

For those interested in exploring this “Pin Risk” phenomenon in more detail check out Jeff Augen’s “Trading Options At Expiration”. Augen presents the academic research and multiple examples of how you can take advantage of these situations using traditional or binary options.

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