It was 3:48 p.m. on Friday April 29 and traders who had purchased Apple (AAPL) April 29 $350 “calls” — options that gave them the right to buy Apple shares in blocks of 100 for $350 per share — were sitting pretty. The stock was trading around $353.50 and those calls were worth more $350 apiece (the difference between the price of the stock and the so-called “strike price” of the option times 100).

Then, in an extraordinary burst of trading — exacerbated by the rebalancing of the NASDAQ-100 scheduled for the following Monday — more than 15 million shares changed hands and the stock dropped below the $350 strike price just before the closing bell. Result: The value of those calls disappeared like a puff of smoke.

For people who follow Apple — investors and speculators alike — it was sickeningly familiar turn of events, one that has its own language and terms of art. The tendency for an underlying stock to close at or near an option’s strike price at expiration is called “pinning.” And the point at which a stock will close to the greatest detriment to anyone holding options at expiration is called max pain. There are websites, like optionpain.com, that will chart, free of charge, the max pain point for any stock for which options are traded.

Conventional wisdom has it that Apple’s shares have been pinned to the max pain point nearly every Friday since weekly options trading began. Based on the stock’s closing prices over the past two months, it certainly seems that way.

In the graph below, we’ve charted eight weeks of daily closing prices indicating how much higher or lower they were than the strike price of the calls nearest to that Friday’s close (marked in red).

As you can see, the stock tends to gravitate toward the red closing strike price, either by moving down (reducing the value of the calls) or moving up (doing the same to the “puts,” options that give the holder the right to sell a stock at a certain price).

Note that the daily chart tends to mask minute-by-minute changes. For example, you would never know, looking at the tiny red bar at April 29 in the chart above, what happened to Apple’s share price in the last few minutes of trading that day.

There’s a whole library of academic research documenting the max pain phenomenon. Perhaps the most famous is a 2005 study in the The Journal of Financial Economics that the
New York Times
reported on the following year. The authors, working at the University of Illinois, examined five and a half years of stock trades and found the pattern charted at right. The percentage of securities that closed within a few cents of the strike price of one of their options was too great to be attributed either to chance or to normal hedging activity. The shares, they concluded, had been manipulated.

For the record, manipulating a stock in this way is illegal. The operative language can be found in Section 9 of the Securities Exchange Act of 1934:

“It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange—

h. To effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security registered on a national securities exchange for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” (emphasis ours).

How is this manipulation being accomplished? Who is doing it? And why aren’t they being punished? Those are very good questions, which we’ll try to address in subsequent articles.