PIN risk refers to the potential risk associated with a financial derivative instrument, such as options or futures contracts, that occurs when the underlying asset's price, known as the spot price, is approaching or very close to the strike price of the options contract.
When the spot price of the underlying asset is close to the strike price, there is a possibility that the contract could be exercised or assigned before its expiration date, resulting in potential losses for the options holder. This is particularly relevant for American-style options, which can be exercised at any time before expiration, unlike European-style options that can only be exercised at expiration.
The term "PIN" stands for "price improvement necessary," which is the minimum amount of price movement required for an option holder to consider exercising the contract. If the spot price is very close to the strike price and the movement needed for favorable exercise is minimal, the risk of early exercise or assignment is heightened and could catch the options holder off guard.
For options sellers or writers, PIN risk poses a challenge as well. If an option gets assigned early due to minor price movement, the seller might not have enough time to adjust their position to mitigate losses or optimize potential profits.
Traders and investors commonly monitor PIN risk carefully when the underlying asset's price approaches the strike price to assess the likelihood of early exercises or assignments, allowing them to adjust their positions or implement risk management strategies accordingly.
