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Last updated on September 13th, 2022 at 10:24 pm
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Options are derivative instruments that owe their value (or lack thereof) to the underlying asset’s movement. Is it possible for the roles to be reversed? Can Call/Put options affect the stock price?
Call or put options would not affect the price of the stock prior to their expiration. However, if there are many calls or puts that will be in the money at expiry it can cause the stock price to fluctuate as people have to buy shares to make good on their obligations.
Call or put options can affect the stock price in that scenario. The intricacies surrounding the fulfillment of options contracts nearing or at expiry can lead to “gamma explosion” and “strike price pinning.”
Both terms are common examples of (sometimes short-lived) stock price movements caused by call/put options.
Say for example a certain stock has thousands of call options in the money (above the strike price) and all of those were sold as naked calls (meaning there was no stock to back them up). As the options get close to the expiration date people will have to start buying the stock to “cover” the position.
As those calls are getting covered it may cause the stock price to increase because of the increase in demand for the stock. How much it will increase (if at all) will depend on the size of the company and how many shares typically change hands in a day/week.
In the rest of this article I will take a closer look at the argument and try to help you understand how the options market can affect stock price movements.
The Relationship Between Stock Price and Options
To understand the influence of options on stock price, you need to first learn the correlation between both of them.
In any options contract, the buyer has the right to buy or sell shares once the designated strike price is breached in the future. As soon as the buyer elects to exercise that option, the seller is mandated to either buy or sell those shares (depending on if it was a call or put).
While anyone can buy and sell options, options sellers are typically large financial institutions (also known as market makers).
These market makers (and everyone else) monitor their risk using tools like Gamma and Delta (or the Greeks). The values of these Greeks influence the actions of the market makers as an options contract nears expiry.
How Call/Put Options Affect Stock Price
Traditional investors often argue that options trading can’t affect the demand and supply of stocks because they are just a bet on the movement of the specific stocks. The go-to analogy is conventional gambling, where bets on a result don’t affect the outcome.
However, there are many examples of match or race fixing to show that the gambling analogy is poor. When there’s a lot of money at stake, people will look for ways to bend the rules.
The Gamestop and AMC stories are the most recent examples of this.
In the options trading world, institutional investors looking to cover their risk, as highlighted by Gamma or Delta, will typically run to the stock market for solutions. Such a reaction often affects supply and demand on the market—even if it’s only in the short-term.
Below are two main scenarios depicting how call/put options can affect the stock price.
If many options traders believe the price of a specific stock is about to rise strongly in the short term, many of them will buy call options with a short expiry. The sellers of such call options risk having their option exercised, forcing them to sell the specific stock at the designated strike price.
A high number of exercisable options cause what’s known as Gamma explosion for option sellers (market makers).
Let’s consider an example.
David, who has thousands of followers, believes that Stock XYZ will reach a strike price of $62 in a week. He announces his analysis to his followers across social media, and 999 others join him in buying a call option, each with a one-week expiry. Each call option gives them the right to buy the stock at $62 at expiry. The stock goes above the strike price a day to the expiry, making 1000 call options exercisable.
The market makers in this example have to buy more shares of XYZ stock to hedge their position and have 100,000 shares to deliver if David and all his followers choose to exercise their option.
The increased demand will most definitely push up the stock price.
As long as this pattern continues, the market makers will continue to buy more shares (even going to share auctions), pushing the underlying stock price higher. The AMC story referenced above is an example of how the Gamma explosion affects stock price.
You may be wondering why David and the other options traders don’t just buy shares directly instead of going with options. They choose options because they are cheaper.
A call option gives you rights to buy 100 shares of any stock. With stock XYZ in our example above, that would mean spending $6,200 per 100 shares instead of roughly $900 for the call option.
Strike Price Pinning
“Strike price pinning” is another example of how market makers in options trading can influence stock price to maximize returns. Once buyers and sellers are yet to close an options contract, strike price pinning is very likely.
Imagine a scenario where an institutional investor sells 200 call options of stock XYZ at a strike price of $230. If the stock surpasses the strike price before expiry, he’ll have the obligation to sell 20,000 shares to the option buyers at $230 per share.
If the stock goes near or slightly above the strike price, the investor may jump into the spot market and sell enough shares to pull the stock price down to the strike price and avoid having the options exercised. Put option sellers also do something similar.
The resulting back and forth means that the stock price will stay “pinned” to the strike price on the expiry date.
Are the Impacts of Call/Put Options on Stock Price Long Lasting?
The impacts of call/put options on stock price typically won’t last very long. However, this is subjective. It may last long enough for any side of the trade to make outsized returns.
For example, strike price pinning only leads to a minor correction in the stock price on popular option expiry days. The pinning only happens around the most popular strike price and is only possible with low volatility stocks.
However, for the institutional sellers, keeping the options from getting exercised only for a few hours on the expiry day could be the difference between pocketing thousands in premiums and scrambling to offset risk.
The Gamma explosion scenarios tend to have the deepest impact as the tail-chasing between institutional call sellers, and the (largely retail) buyers can go on for weeks.
However, even that doesn’t last too long.
Going back to the AMC example, the share price ballooned upwards in a few weeks. Still, as soon as the institutional investors leaned on liquidity providers and brokers, the party ended quickly for retail traders.
Nevertheless, the stock has managed to retain some of the gains recorded months after. It’s still up more than 1900% ($40) from its starting spot at the start of the year ($2).
Call and put options affect stock prices in different ways. As options buyers and sellers continually look for ways to profit on each contract, the value of the underlying stock is inadvertently affected due to alterations to vanilla supply and demand.