What it means
An option gives the holder the right to buy a share, called a call, or to sell it, called a put, at a set strike price on or before an expiry date. On expiry, an option is worth something only if the share price has moved beyond the strike in the holder's favour.
For each possible expiry price, you can add up how much money all the outstanding call and put options would be worth. The price where that total is smallest is the max pain price, because it is where option buyers collectively lose the most and option writers, who sold the contracts, pay out the least.
The theory suggests that because market makers and large sellers hedge their positions, their trading can nudge the share price towards that level near expiry. Supporters point to cases where prices seem to pin to a strike, though the evidence is mixed and other forces often dominate.
Traders use max pain as one input alongside the price chart, volume and news. It is calculated from the open interest, which is the number of contracts that remain outstanding, so it changes as new contracts are traded.
Critics point out that the calculation is simple, the effect is hard to prove and the market contains many participants with different aims. It works best, if at all, in very liquid shares with heavy options trading and no big news, so it should not be the basis for large decisions.
In practice
Real-world examples.
Example
A trader notices that a popular share has most of its open interest at the $100 strike. She expects the price to hover near $100 into the Friday expiry and sells short-dated options accordingly.
Example
A financial blogger publishes the weekly max pain level for a large technology share. Followers use it as a rough guide to where the price might settle on expiry day, although results vary.
Example
A fund manager hedging a large holding notices heavy option activity at one strike. She avoids placing a large order in the last hour before expiry, when the price may be pulled around by hedging flows.
Formula
Calculation
Total payout at price P = Sum over calls of (max(P - strike, 0) x open interest x 100) + Sum over puts of (max(strike - P, 0) x open interest x 100)
Max pain = The price P that gives the smallest total payout
Take three strikes with open interest in contracts, each contract covering 100 shares. Calls: 1,000 at $50, 500 at $55 and 200 at $60. Puts: 200 at $50, 500 at $55 and 1,000 at $60.
At an expiry price of $50, the calls pay nothing and the puts pay (55 - 50) x 500 x 100 = $250,000 plus (60 - 50) x 1,000 x 100 = $1,000,000, a total of $1,250,000. At $55, the calls pay (55 - 50) x 1,000 x 100 = $500,000 and the puts pay (60 - 55) x 1,000 x 100 = $500,000, a total of $1,000,000. At $60, the calls pay (60 - 50) x 1,000 x 100 = $1,000,000 plus (60 - 55) x 500 x 100 = $250,000, a total of $1,250,000 and the puts pay nothing. The smallest total is $1,000,000 at $55, so the max pain price is $55.Case study
Seen in the real world.
Summit Trading Desk is an illustrative, fictional firm whose analyst tracked the max pain price of ten large shares for six months and compared it with where each share actually closed on expiry day. In her sample, the closing price was within 1% of the max pain level in about half of the cases.
Her manager asked the right question: how often would a random price have landed that close? The analyst checked and found that, for the quiet shares in the sample, a price within 1% of any nearby strike was almost as common.
The firm concluded that max pain was a mildly interesting indicator rather than a reliable signal. In this illustrative story the desk kept it on a dashboard, but never sized a position on it alone.
Watch out
Common mistakes.
- Treating max pain as a guarantee that the share will close at that price on expiry.
- Using stale open interest data, which changes daily and alters the calculation.
- Forgetting that news, earnings and broad market moves can overwhelm any pinning effect.
Questions
People also ask.
What does max pain mean?
It is the price at which the total payout to options holders is smallest, which means the most pain for buyers and the least for sellers.
Does the share price really move towards max pain?
Some studies and traders see a pull in certain situations, but the effect is inconsistent and may be explained by other factors.
Is max pain the same as maximum loss?
No, because it describes a price level that minimises total option payouts and not the largest loss on any single position.
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