It is well known that the premium paid for an option will be directly affected by the price of its underlying. Options are called derivatives. Their current value derives directly from the movement of their underlying price. Does the opposite hold true? Can the option price be affected by the value of the option?
The answer is no. Since options are derived directly from the underlying, the opposite can’t be true. It’s the same reasoning as when we observe that rain does not cause sidewalks to puddle. Many traders however believe that options can have an impact on the underlying. While there may be some observed causes and effects, logic should prevail.
Most commonly, the if pinning example is used to illustrate how options can cause stock prices to move. Stock prices will tend to move towards the closest strike option just before expiration. (This is called “pinning to the strike”). This is because stock trading occurs with expiration prices in mind. Covered call writers are a common culprit. Are options causing stock prices to move in this example? No. It is a simple example of trading behaviour in stock based on the proximity between stock price & option strike. This is a temporary phenomenon and is caused strictly by underlying trading and no options.
This reasoning behind the belief that options trading service can affect the underlying price is based on an argument that increased interest in options must lead to greater interest in the sub-underlying. While this may sound reasonable, it isn’t always true. Most traders know that there are two kinds of traders. First, there is the covered call author. This conservative trader accepts low risk and a limited profit. The second category is the thew-speculator. He or she will likely trade-in options and not take on equity. This is not always a high-risk trading strategy. The risks associated with trading strategies that include offsetting positions can be reduced. However, the question is still: How do these general trader categories affect the prices of the underlying asset?
The covered call writer may not be interested in keeping equity for the long term. He or she might be more willing to let 100 shares go if the strike prices exceed the trader’s stock basis. Covered calls are not likely to cause stock prices to move beyond temporary pinning. Speculation can’t affect stock prices because it usually only involves trading in options contracts and no equity position, whether long or short.
However, traders can fall prey to a logic trap and mistakenly consider certain combinations as stock positions. Synthetic positions can mirror stock price movement point-for-point. A synthetic long stock trading involves a long put and a call. This trade can usually be set up quickly and with very little expense (or even net credit). A synthetic short stock trade is a combination of a long put or a short call. It performs well when the stock price falls. Both synthetics offer the same strike, with both sides usually receiving the same strike at the current price of their underlying.
It is important to note, however, that a synthetic place is not. This is different from a long or a short position in the stock. It is a “side wager” on how the stock price will perform between entry and expiration. A synthetics trader can make a profit on a decrease in time value alone or combined with increases in long-position intrinsic value. These do not affect the stock’s behaviour. The rational view of synthetics is that each option’s pricing is independent of stock price behaviour. The price of those options will benefit or hurt from changes in stock prices, depending on how the underlying movements. Although synthetic positions may appear to have an impact on stock price behaviour, this is not supported by logic. Options activity does not affect the supply or demand for shares of the underpinning.
