I’ve come across max pain theory lately and still confused about it.
It seems to relate to where stock prices settle at expiration. Can someone explain how it works in real trading?
Does it actually predict price movements or is it just a theoretical concept?
It can guide trades. Last year, I saw it work around 65% of the time.
Max pain identifies the strike price where most options expire worthless at expiration.
Calculation:
• Add open interest for calls and puts
• Find strike with highest total dollar loss for option holders
• That is max pain level
Stock prices gravitate toward this level due to market maker hedging. Accuracy drops with high volatility or major news.
Learned this the hard way when I ignored max pain on Apple options two months ago.
The stock was trading at $185 but max pain showed $180. I bought calls thinking it would keep climbing.
Sure enough, Apple drifted down to exactly $180 by Friday expiration. Lost $400 on that trade.
Now I check max pain levels before entering any options position, especially on expiration week.
The theory suggests that options market makers influence prices to settle at levels that cause the most losses for retail traders.
As expiration approaches, they adjust their hedging, which can push stock prices toward the max pain point.
In my experience, this theory holds better for stable stocks without significant news. Volatile stocks often disregard max pain altogether.
It’s wise to consider it as one factor among others instead of depending solely on it.