Risk Pound-to-Dollar Rate Could be Moved by "Huge" Option Expiries Later in the Week

- Thursday sees large option expiries which could impact the exchange rate

- Most of the largest expiries below the current exchange indicating a possible bearish bias

- Exchange rate tends to bob around the expiration level close to the time, say experts

Image © Goroden Kkoff, Adobe Stock

"Huge" Sterling option expiries on Thursday and Friday the 19th and 20th of July could impact the GBP/USD exchange rate on those days, according to Richard Pace, a correspondent at Thomson Reuters.

"Huge expiries Thursday - 1.8bln 1.30, 1.3bln 1.3125, 1.1bln 1.3455," says Pace, adding, "these options already rewarding longs over recent sessions."

The promise of technical moves in the market will make for an interesting week for Sterling which already faces hurdles in the form of a slew of high-level economic data releases and political intrigue.

Owners of Call options contracts will make huge winnings assuming the market remains elevated as they will be able to exercise their options and buy GBP/USD at a bargain price of 1.30 or 1.3125.

Option expiries on Friday are not as large but still considerable, with the following levels seeing expiries: 1.3185 (307m), 1.3200 (295m), 1.3325 (430m), 1.3450 (1.1bn).

Option expiries of above 600m can impact the exchange rate as they tend to act as a "magnate" to price, says Jarratt Davis, a renowned forex trader and hedge fund manager.   

In a phenomenon which is also known as 'pinning' the market tends to bob up and down around the expiry level as option writers try to manipulate the market in their favour buying and selling to get the spot price as close to the strike price as possible.

"Very often an option expiration of a certain price will act almost like a magnet. For example, if you got an option expiration of a billion on EUR/USD at 1.10 the price will tend to gravitate around 1.10. It might come up maybe beyond 1.10 a little bit but most likely it will eventually come back down. In a way it will just hover around option expiration price until the time of the cut," says Davis.

The "cut" or the exact time of expiration is 14.00 GMT on the day of expiry and this is when the most option-related activity occurs, according to veteran dealer and analyst at Liveforex.com Mike Patterson.

This suggests the up and coming expiries could have bearish, downwards effect on the exchange rate at the end of the week, since the majority of options expire below the current market rate of 1.3249, although much depends on what the market price is at the exact time of expiration.

If the market moves substantially higher between now and Thursday, however, and moves further away from the option expiries in the lower 1.30s, there is a risk that the option expiry will actually exacerbate the short-term bullish tenor of the market in a phenomenon that is known as 'Gamma Explosion' (GE).

GE is when option contract writers give up trying to manipulate the exchange rate towards the strike price as a lost cause, and instead decide to essentially throw in their lot with the other side and 'join' the uptrend, thus causing further upside in the underlying exchange rate.

Obviously, as Davis says, the actual impact on the exchange rate from expiries depends a lot on the exact type and combination of options expiring and whether they are options to buy (call) or sell (put).

This data, however, is often very difficult to get hold of and therefore traders should use large option expiries as guidelines more than exact indicators, and the best way is to see them as potential magnates for price as in the case of 'pinning'.

"Obviously, the whole answer to the question is complicated. It involves strike prices and calls and whether or not trades are going to be exercising those options. This kind of information, as I said, is very difficult to get hold of. But the simple way of trading this is understanding that really big expiry orders (I'm talking maybe over $600 million to a billion to $2 billion to $3 billion) tend to act like a magnet to the price," says Davis.

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