fellas, now how dependable is this concept of max pain.
So-so. It is, of course, badly named, as it causes pain only to those holding in-the-money options whose intrinsic value shrinks or disappears in the final days before expiration.
What really happens is that as in-the-money options positions are unwound toward expiration, the unwinding generates price pressure on the stock in the direction of the option's strike price. For example: if there's a large open interest in November 35 COMS calls, traders will be buying up these options in the next 24 hours or so, at a slight discount to their intrinsic value, exercising the option, and selling the stock at market, pocketing the small difference. All that stock selling tends to drive the price down ... until it reaches 35, at which point the November 35 puts are in the money, which causes the "mirror image" effect, as traders buy the puts and the stock, and then get rid of the stock by exercising the put. Thus, the stock price tends to converge toward an option strike price at options expiration.
The larger the open interest in a particular in-the-money option, the stronger the "pull" toward that strike price.
This effect is undeniable, but is also easily overwhelmed by other forces acting on the price. It definitely is not something you can depend on for any individual stock and expiration date. For fun and education, take a look at the closing prices of the stocks you follow tomorrow -- how many of them are at or really close to an option strike price? |
