Maximum pain theory

The maximum pain theory is that the majority of traders who buy and hold options contracts until expiration will have an options contract with a lower value than which it was purchased.

Maximum Pain is the point at which most call and put option contracts become worthless when they expire.

The Strike of Pain is the strike price with the lowest In-the-Money value for both calls and puts on a given stock for a given expiration date. This is the strike where the long option traders will lose the most money and the short option traders will gain the most value. The Strike of Pain is calculated by taking the open interest of the various In-the-Money strike prices multiplied by the amount that the call or put is In-the-Money. The In-the-Money values are added together, and the strike with the lowest monetary value is the Strike of Pain. The Strike of Pain calculation is based on the theory of Max-Pain developed by BCA Software.

It is believed that stocks will have a tendency to gravitate to the Strike of Pain on expiration day. There is evidence that this tendency exists, but there is still debate on whether this is caused by manipulation, market forces, or by mere chance. It is important to note that such events such as market upheaval, price momentum, breaking news or extreme earnings reports will negate the Strike of Pain value. It is also important to note that the Strike of Pain price is more reliable within the last week until expiration. The Strike of Pain value for a 6-month out target month may be inaccurate as the open interest can drastically change between now and the 6-month expiration date.

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