The "Max-Pain Point™" Options Analysis
technique:
There is a Wall Street axiom that says "90% of all the options that are bought and held to expiration
will expire worthless". This means that 90% of the time the people who 'write' the option and
collect the premium, never get their stock 'called' from them or get stock 'put' to them. Whether the
actual percentage is 90% or something lower is irrelevant to the evaluation of the Max-Pain™
effect.
The perception that most traders, who buy and hold options until expiration, will lose has also been
called the theory of maximum pain or Max-Pain Point™ or just Max-Pain™, for short.
There has been some analysis of this hypothesis in Silicon Investor discussion boards, eg Trading
IOMEGA based on technical analysis. There are also extensive discussions of this effect, also
called 'strike price pegging', in the archives of both Jim Cramer's "Wrong!" column and the
"Saturday Options School" column at http://www.theStreet.com
Some references:
http://www.thestreet.com/comment/wrongtactics/10399.html
http://www.thestreet.com/comment/rewrite/703618.html
http://www.techstocks.com/~wsapi/investor/reply-1967533
http://www.techstocks.com/~wsapi/investor/reply-1975602
http://www.techstocks.com/~wsapi/investor/reply-1977966
By looking at the price of the underlying issue, on the last trading day before option expiry, (Note:
options officially expire the day after the third Friday of the month.) it has been seen, with statistical
significance, that the closing stock price tends toward the option strike price that forces the greatest
number of options to expire in a worthless condition.
Whether this tendency is deliberately caused by some conscious effort at market manipulation or is
just a result of some natural market law of supply and demand, has not been investigated nor
hypothesized by this analyst. What is significant, however, is to be aware that this effect does seem
to be a tendency that occurs during those times when there is not some major market upheaval,
price momentum, or breaking news relative to the stock in question.
Max-Pain Point™ analysis example using the September 1998 Options data for
SUNW:
I present here a snapshot Max-Pain™ analysis of the September options of Sun Microsystems, as
of end-of-day, August 31, 1998. It should be remembered that options trade every day and the
amount of Open Interest and it's distribution across the various striking prices may vary greatly
during the time before option expiry.
This work is illustrative in nature only, and does not constitute investment advice. In
any case, neither Benjamin Antanaitis, Jr nor BCA Software will be held liable for
any investment decisions that may be made by anyone who views this web page.
To start the Max-Pain™ analysis, list the available spectrum of strike prices and total Open Interest
volume for the September '98 Puts and Calls.
This data is directly available from the CBOE at their website:
http://www.cboe.com/DelayedQuote/QuoteTable.aspx
Then calculate the cumulative total value of the current Open Interest positions, as if they are held
to the expiry day, over a range of closing prices for the underlying issue, SUNW. Assume the stock
price is at a given strike price, calculate the cumulative value of all the calls struck below and all the
puts struck above that value. Repeat the calculation at each strike price over the range of interest.
You get a table of values that appears like this:
It can be seen that as the possible price of SUNW increases over the range $37.5 - $62.5, the total
value of all the CALLS increases, while the total value of all the PUTS decreases. In contrast, as the
hypothetical price of SUNW decreases down the range, the total value of all the PUTS increases,
while the total value of the CALLS decreases.
Two separate curves are then plotted on a common graph versus a common X-axis (the range of
potential stock price closing prices on expiry day.) :
1.
2.
The total value of the PUT positions
The total value of the CALL positions
To determine the point where the most options would expire worthless, maximizing the profit to
the option 'writers' and minimizing the profit to the option speculators aka the option buyers, you
need to combine ie add the value of the two curves at each data point and then look for the
minimum value point (the Max-Pain Point™) of this 'combined' graph.
This graph is the sum of the PUT curve and the CALL curve. The point at which the most options
expire worthless is labeled and is the point where the overall minimum value occurs (the Max-Pain
Point™). It appears to be at the $47.50 closing price point.
Conclusion: If all things held equal from now until options expiry
day, and no breaking news occurs, no Alan Greenspaning is
occurring, no unstoppable price momentum events are occuring,
then the hypothesis is that the closing price for SUNW would tend
to be 'attracted' to a price near $47.50. This is the price that would
cause the most loss for option holders and most gain for option
writers ie the Max-Pain™ point.