As most of you probably already know, the point of "maximum pain" is defined as the price where the option buyers have the least equity at expiration. Said another way, the max pain price is the price at which the option writers (typically market makers) make the most profit. Traders like to keep their eyes on this sort of thing because there is often a driving force in the market to push stock prices in this direction up to expiration. The idea is that the option sellers have massive capital to maximize their profit. Further, most option buyers don't really want to hold an option to expiration. As profits are taken the average pressure would be to move the stock towards maximum pain. Its often the case that a stock will "pin" to a round number at expiration. Generating these plots requires a simple calculation, you just figure out what the net value would be of all options in a given month if the stock closed at said price. All you need is the open interest for each strike. The total value will have a minimum at some price which is the max pain point.
Take IWM for example, the max pain for May lies just a few dollars below where we are now but the curvature of the minimum is such that the option equity wouldn't change significantly from strike to strike near $48. If you mouse over these plots it gives the total value of the options if the stock were to close at a given price and the options expired today. In this plot I highlighted $68 and the toal came out to $1B and was dominated by call options. If IWM closed at the max pain point the total value would be split more evenly between calls and puts and the total would be about $150M, significantly less.
I've got a few more of these plots to demonstrate how different the max pain curve can look from stock to stock (or month to month). DNDN has seen some action this month and shows that the open interest can be spread out over a wide range of strikes. It also shows a big barrier near $30.
In GS you can see that there are a lot more May puts out there than May calls, this might provide support for the stock if it tried to fall. Max pain for GS is $125 which is 10$ below current prices.
UNG is a natural gas etf that has seen some increasingly bullish sentiment as it rallied from all time lows. For one thing you can see that there are a lot less strikes on UNG. You can also see that in May most of the outstanding options are calls and a good chunk of them are in the money. Max pain is about 20% below here.
In contrast, the SPG May options are dominated by puts. Option sellers must have made a fortune selling puts on SPG for this month's strike. I think its interesting how rapidly the call value would rise if SPG did try and move up from here. Basically, it looks like SPG won't budge an inch this week. Its right on the money already.
Just as a quick disclaimer, I'm not advocating trading front month options or even trading options in general. Trading front month is a very easy way to go broke. They can go up 100%'s in a day but they can easily drop 90% in a day too, especially this close to op ex. Also, these max pain prices can and will change with market activity. Since the out of the money options are so increasingly cheap near expiration, the volume surges and can throw the open interest induced max pain price. Further, some stocks have much heavier options activity and a much bigger amount of market equity in those options. The stakes are higher in those cases for max pain to work out (or not). I wouldn't think UNG is driven by option activity, its driven more by natural gas commodity prices and those are driven by a number of different factors. You'd also want to take into account futures and futures options open interest for commodities like natural gas. SPG or GS, on the other hand, might be more effected by options expiration.
Good luck this week!
Disclosure: I own GS puts.
4 comments:
...please where can I buy a unicorn?
...please where can I buy a unicorn?
Chill dude, i'm working on it.
This is another great max pain resource
maximum-pain.com
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