Investor's wiki

Max Pain

Max Pain

What Is Max Pain?

Max pain, or the max pain price, is the strike price with the most open options contracts (i.e., puts and calls), and it is the price at which the stock would cause financial losses for the largest number of option holders at expiration.

The term max pain comes from the maximum pain theory, which states that most traders who buy and hold options contracts until expiration will lose money.

Understanding Max Pain

As per the maximum pain theory, the price of a underlying stock will in general float towards its "maximum pain strike price" — the price where the best number of options (in dollar value) will terminate worthless.

Maximum pain theory says that the option journalists will hedge the contracts they have written. On account of the market maker, the hedging is finished to stay neutral in the stock. Consider the market maker's position in the event that they must compose an option contract without needing a position in the stock.

As the option expiration draws near, option essayists will try to buy or sell shares of stock to drive the price toward a closing price that is profitable for them, or possibly to hedge their payouts to option holders. For example, call essayists will believe the share price should go down while put authors might want to see share prices go up.

Around 60% of options are traded out, 30% of options terminate worthless, and 10% of options are [exercised](/work out). Max pain is the point where option owners (buyers) feel "maximum pain," or will remain to lose the most money. Option sellers, then again, may remain to receive the most benefits.

The maximum pain theory is disputable. Pundits of the theory are partitioned whether the inclination at the underlying stock's cost to float towards the maximum pain strike price involves chance or a case of market manipulation.

Working out the Max Pain Point

Max pain is a simple yet tedious calculation. Basically, it is the sum of the outstanding put and call dollar value of each in-the-money strike price.

For each in-the-money strike price for the two puts and calls:

  1. Find the difference between stock price and strike price
  2. Duplicate the outcome by open interest at that strike
  3. Include the dollar value for the put and call at that strike
  4. Repeat for each strike price
  5. Find the highest value strike price. This price is equivalent to max pain price.

Since the max pain price can change daily, if not from one hour to another, involving it as a trading instrument is difficult. Notwithstanding, it is once in a while important to note when there is a large difference between the current stock price and the max pain price. There could be a propensity for the stock to draw nearer to max pain, however the effects may not be significant until expiration draws near.

Illustration of Max Pain

For instance, suppose options of stock ABC are trading at a strike price on $48. Notwithstanding, there is critical open interest on ABC options at strike prices of $51 and $52. Then, at that point, the max pain price will settle at both of these two values since they will make the maximum number of ABC's options lapse worthless.

Adjustment, Jan. 16, 2022: A previous rendition of this article erroneously stated that put holders believe share prices should go up. As a matter of fact, put holders profit from lower share prices, while put essayists profit from higher ones.

Features

  • Max pain, or the max pain price, is the strike price with the most open contract puts and calls and the price at which the stock would cause financial losses for the largest number of option holders at expiration.
  • Max pain calculation includes the summation of the dollar values of outstanding put and call options for each in-the-money strike price.
  • The Maximum Pain theory states that an option's price will float towards a max pain price, at times equivalent to the strike price for an option, that makes the maximum number of options terminate worthless.