Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
In options trading, the term “max pain” is short for “maximum pain price,” and refers to the strike price where the most open interest exists — open interest being the total number of active options contracts that haven’t been settled or closed.This max pain figure combines both puts and calls, representing the price at which option buyers face the highest potential losses at expiration.
Although max pain theory’s price movement predictions aren’t guaranteed, understanding how it works can help traders understand market dynamics at an option’s expiration.
Key Points
• Max pain is the strike price resulting in the highest losses for option buyers at expiration.
• Stock prices might move toward the max pain price as expiration approaches.
• Calculating max pain involves assessing the dollar value of open interest for calls and puts at each strike.
• Advantages include systematic trading and potential benefits from market behavior, but disadvantages exist.
• Controversies arise from potential market manipulation by large institutions to influence stock prices.
What Is Max Pain?
Max pain, or the maximum pain price, is the strike price with the most open options contracts combining puts and calls.It is the strike price where the greatest number of options will expire out of the money, or worthless, causing the highest dollar value of losses among option buyers on a given stock at a specific expiration.
Some large institutional options sellers see an investment opportunity in writing options that eventually expire worthless, according to max pain theory. If options expire worthless, the seller of those options keeps the entire premium as profit. Option sellers face significant risk with this strategy, as they are obligated to fulfill the contract’s terms if exercised.
Max pain options trading stems from the Maximum Pain Theory. The theory contends that option sellers seek to hedge portfolios with options expiration. The Maximum Pain Theory also suggests an option’s price will arrive at a max pain price where the most options contracts held through expiration will experience losses. Bear in mind that an options contract that is not “in the money” at expiration is worthless.
Recommended: Popular Options Trading Terminology to Know
How Max Pain Works
The Maximum Pain Theory asserts that the price of the underlying asset is likely to converge at the maximum pain strike price. The max pain price is the strike with the greatest dollar value of calls and puts. As the expiration date approaches, the underlying stock price might “pin” to that option strike price.
Some day traders closely monitor the max pain price on the afternoon of expiration – usually the third Friday of the month for monthly options or each Friday for weekly options contracts.
Max Pain trading can be controversial, with some critics suggesting that attempts to influence stock prices near expiration could raise regulatory concerns (or even be considered market manipulation). Market participants disagree about whether or not Max Pain Theory works in practice. If a trader can predict which strike price will feature the greatest combination of dollar value between calls and puts, the theory states that they could profit from using that information.
Some market makers may consider Max Pain Price Theory when hedging their portfolios. Delta hedging is a strategy used by options traders — often market makers — to reduce the directional risk of price movements in the security underlying the options contracts. A market maker is often the seller of options contracts, and they seek to hedge the risk of options price movements by buying or selling underlying shares of stock.
This activity can cause the stock price to converge at the max pain price. Delta hedging plays a significant role in max pain trading.
How to Calculate the Max Point
Calculating the max pain options price is relatively straightforward if you have the data. Follow these steps to determine the max pain strike:
• Step 1: Calculate the difference between each strike price and the underlying stock price.
• Step 2: Multiply the difference calculated in Step 1 by the open interest for calls and puts at each strike price, determining the dollar value at that strike.
• Step 3: Add the dollar value for both the put and the call at each strike.
• Step 4: Repeat Steps 1 through 3 for each strike price on the option chain.
• Step 5: The strike price with the highest dollar value of puts and calls is the max pain price.
Since the stock price constantly changes and open interest in the options market rises and falls, the max pain price can change daily. An options trader might be interested to see if there is a high amount of open interest at a specific price as that price could be where the underlying share price gravitates toward at expiration, at least according to Max Pain Theory.
Max Pain Point Example
Let’s imagine that a stock trades at $96 a week before options expiration. A trader researches the option chain on the stock and notices a high amount of open interest at the $100 strike. The trader performs the steps mentioned earlier to calculate the max pain price.
It turns out that $100 is, in fact, the max pain price. Since the trader believes in Max Pain Theory, they go long on shares of the stock, assuming that it will rise to $100 by the next week’s options expiration. Another options trading strategy could be to put on a bullish options position instead of buying shares of the underlying stock.
This hypothetical example looks simple on paper but many factors influence the price of a stock. For instance, there could be company-specific news issued during the final days before expiration that sends a stock price significantly higher or lower.
Macro factors and overall market momentum may affect stock prices, potentially reducing the influence of max pain dynamics. Finally, stock price volatility could cause the max pain price to shift in the hours and even minutes leading up to expiration.
Pros and Cons of Using Max Pain Theory When Trading
Max Pain Options Theory can be an effective strategy for options traders looking for a systematic approach for their options strategy. That said, not everyone agrees that Max Pain Theory works in practice. Here are some of the pros and cons of Max Pain Theory.
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Pros:
• A systematic approach to trading options
• Trades the most liquid areas of the options market
• May benefit from price trends tied to behavior of other market participants
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Cons:
• Lack of agreement supporting the theory
• Stock prices don’t always gravitate to a max pain price
• Other factors, such as market momentum or company news, could move the stock price
Options trading has become more accessible today due to low or no commission online investing. Previously, higher transaction costs made options trading less feasible for retail traders with smaller account sizes. It was not economical for average retail traders with small account sizes to buy and sell options using max pain theory.
Critics contend that there should be more regulatory oversight on max pain price trading — particularly on large institutions that could be manipulating prices. The regulatory future for these practices remains uncertain.
The Takeaway
Max Pain Theory is a framework in options trading that focuses on strike price, which may potentially result in the most losses for buyers at expiration. Options traders who calculate the max pain price, can use that information to inform their investing strategy, but outcomes are not guaranteed. While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
FAQ
What does max pain indicate?
Max pain indicates a specific strike price — specifically, It is the strike price that causes the highest dollar value of losses among option buyers on a given stock at a specific expiration.
What is max pain manipulation?
Some suggest that the max pain theory is related to market makers manipulating the overall options market, in an attempt to make the most number of options possible expire worthless.
Photo credit: iStock/valentinrussanov
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