Pin risk

Option theory
Some instruments are cash settled at maturity, such as index options. Other instruments are physically settled at maturity, such as stock options. What additional risk does your portfolio with stock options have compared to the portfolio with only index options?


This has not been discusses in the theory. However, you should be able to answer this question. Think about the obligation that the seller of an option contract has towards the buyer of the option contract.


This additional risk is called pin risk. If you are short in an option that ends up ATM at maturity, you don't know for sure if the counter-party will exercise the option or not. If the counter-party would exercise the option, you are obligated to deliver the stock. In that case, you will need to buy the stock from the market. This could lead to a situation in which you need to buy the stock at an undesired price level, if you wait for the counterparty to act.