Options Max Pain Theory
What is options max pain theory?
Max pain theory suggests that the underlying price for the option, or the stock price in simpler terms, will be pinned to a specific price at options expiration, also known as op-ex. This would inflict the maximum amount of pain in dollar loss to all options holders, which includes those that bought calls and put contracts. The max pain price is the strike price with the most open contracts of calls and puts that would cause the greatest amount of losses. The theory suggests that a stock's price will gravitate toward the max pain price as the expiration date nears. Doing so would cause most of the options to expire worthless and thus inflict "max pain".
Can a stock be manipulated?
Most of the time option writers, or Market-Makers, will hedge contracts they have written to remain neutral on the stock. The way they hedge is by doing the opposite of the contract they wrote. I won't get into too much detail about this here, because talking about hedging and option greeks would require several pages written on it's theory, but in short, if the Market-Maker sells (known as writing a contract) a call contract, they will buy the stock and if they sell a put contract, they will sell the stock (short-sell it). As the expiration draws near, option writers may buy or sell shares of the stock to drive the price toward the max pain point. It requires vast amount of capital to do this, but the market maker will be able to profit more from allocating capital to drive the stock price in order to lose the minimal amount of value from the options contracts written.
The maximum pain theory is controversial as it would indicate that markets can in fact be manipulated. Does the tendency of the stock price to gravitate toward the maximum pain strike price happen by chance or is it a case of market manipulation?
How to view Max Pain for a ticker
Use our to view the max-pain chart for a stock. For example, let's use the SPY ticker in the chart below. The stock's max-pain price would be where the bars for both the calls and the puts are shortest. The max-pain point is calculated by scanning call and put contracts and cross-referencing them against each possible strike price at close. The graph shows the cumulative value of each type of contract (call or put) at each strike price. As the strike price at expiration drops, it would increase the cumulative value of in-the-money PUTs at each strike, and as strike price at expiration goes higher, it would increase the cumulative value of in-the-money CALLs at each strike. Thus, the max pain will be where the sum of values for PUTs and CALLs will be the smallest. In this example, we can see that the max pain strike is at $302 for the SPY on June 5th.
