Maximum Pain is one of those lovely/wacky theories out there in options-land: unproven, anecdotal, sometimes true & awe/fear/anger-inspiring. It’s essentially a big ‘FUCK YOU‘ to the option-buying public from the Market Makers/assumed option sellers/hedgers. Yes, the market is indeed out to get you. Depending on your mindset, that may strike a cord…
The theory mostly stems from the general assumption/old-wives’-tale that [make up a percentage, say 80%] of all options expire worthless on Expiration Friday (like today). While this is patently untrue (the vast majority of options are traded, rather than held, well before expiration), the idea/myth/legend remains.
And sure, no doubt there’s something to it. Afterall, most options are sold by the BIG BOYS who leverage them against vast quantities of underlying stock…so, theoretically, if they wanted to truly manipulate the market, they could sell/buy the underlying as needed. As net sellers of options, they would definitely have vested interest in seeing as many of those expire worthless as possible.
It’s at that this point that we have Max Pain for the little guy. It can be found by calculating the total dollar value of all open contracts (based on open interest vs. strike price). Whichever strike gives the LOWEST total value (held by the options buyers) is the point of Max Pain. At this point, the sellers maximize their gain, while the buyers/suckers maximize their pain.
Easy-peasy. Luckily, you don’t have to calculate this by hand…the internet is your friend & valuable resource! Optionistics has an excellent online calculator/grapher, although they call it the “Strike Pegger” (the price to which the underlying will get pegged in order to cause Max Pain).
Even if this sounds a little too far fetched for you, it’s something that you might want to keep in mind as you head into this year’s last (& triple witching) options expiration Friday. So let’s take a look at a few high (options) volume names and see how close we get to the predicted “pegs.”
SPY – Max Pain: 108. (with a positive bias)
Change needed to hit peg: -2%
QQQQ – Max Pain: 43 (with a negative bias)
Change needed to hit peg: -1.87%
C – Max Pain: 4. (with a negative bias)
Change needed to hit peg: 25%
AAPL – Max Pain: 195. (with a negative bias)
Change needed to hit peg: 1.64%