Mike,
As I understand it, the Maxpain theory hold that, as option expiration approaches, a stock will move to the price where the open interest is the greatest, that is, where the most options will expire with the least value. The thought behind it is that market market makers somehow lose less money if more options expire worthless.
There are many problems with this theory. First of all, options market makers on the Chicago Board Options Exchange make their living from the spread. They try to remain delta neutral, that is, balance puts, calls, buys and writes with being long and short the stock to remain neutral and gain a return that roughly matches treasuries. If they do their job right, they have no incentive to manipulate the share price to any particular strike price. In addition, with a stock like AOL, which trades enormous daily volume, it is extremely hard to manipulate anything.
Second, as I just mention in the other post, at-the-money options are always the most heavily traded. The longer a stock hangs around a given price, the more option contracts are opened around that price. As you get close to expiration, many people write options a little away from the money, say, calls 3% above the money and puts 3% below the money, which means more and more of the open interest will zero in on the price the stock is trading at during the week of options expiration. Because of this zeroing-in effect, it appears month after month that the stock closes at the point of highest option open interest. In fact, the open interest is the highest there because that's where the price is.
Best,
--Steve |
