Max Pain Theory
Max pain is the stock price at which the maximum number of options (both calls and puts) would expire worthless, causing the most financial loss to option holders and the least payout from option sellers.
View Max Pain on Unusual Whales.
Also available through the Discord bot using command /max_pain
How it works/Theory
Here's how it works: When options expire, calls expire worthless if the stock price is below the strike price, and puts expire worthless if the stock price is above the strike price.
Max pain theory suggests that market makers and large institutions have incentives to push the stock price toward the level that maximizes these worthless expirations.
For example, if there are many call options at $100 and many put options at $90, the max pain point might be around $95 - high enough to make most of the $100 calls worthless, but low enough to make most of the $90 puts worthless too.
The theory is somewhat controversial. Some traders believe stocks tend to gravitate toward max pain levels near expiration dates, while others see it as just one factor among many that influence stock prices. It's calculated by looking at the total dollar value of outstanding options at different strike prices and finding where the combined losses would be greatest.
Calculations
Calculating max pain is a easy, but takes a lot of time.
For each in-the-money strike price for both puts and calls:
- Find the difference between stock price and strike price
- Multiply the result by open interest at that strike
- Add together the dollar value for the put and call at that strike
- Repeat for each strike price
- Find the highest value strike price. This price is equivalent to max pain price.
As open interest only updates once a day. a ticker's max pain value will also only update once a day.
TLDR: It is the sum of the outstanding put and call dollar value of each in-the-money strike price.