Adam Warner at Daily Options Report discusses Option Pain Theory and, as a practical matter, the "pinning" of stock prices to cause maximum pain/losses to option buyers.
Prediction for Options? PAIN
Courtesy of Adam Warner at Daily Options Report
A reader asks this
"Ran across this "option pain" calculator tonight. Theory seems to be that just before expiration, option sellers move stock prices to point of maximum pain for option buyers. Ever heard of this? Any merit to the idea? Is it tradeable?"
Short answer is yes and no.
I believe he refers to this Option Pain (Max Pain) calculator. They say "in the option market, wealth transfer between option buyers and sellers is a zero-sum game. On option expiration days, the underlying stock price often moves toward a point that brings maximum loss to option buyers. This specific price, calculated based on all outstanding options in the market, is called Option Pain. Option Pain is a proxy for the stock price manipulation target by the option selling group".
Manipulation as a cause of pinning is wildly wildly over-rated. Think about the numbers for a sec., how much stock someone would have to trade and flip and risk vs. how much they stand to gain on an options short. That "manipulating" options short you think you see ginning the stock to strike is more likely a squeezed option long watching time slip away. That is actually the pain this whole theory is based on, and that’s a very real dynamic.
But be that as it may, not here to prove or disprove manipulation, it’s not the important question. We’re trying to make money here, so is this a tradable dynamic?
Yes, pins do happen, but it’s not nearly as simple as the methodology this site implies. And as I understand it, the methodology sounds off.
What you do is hit up a symbol, and out pops a chart. As they say "Option Pain point is represented by the lowest bar in the chart. At this price, all the options in the market have the smallest dollar value." So I enter AAPL, and out pops $115.
Why? Appears to be because there is large put open interest in the Jan 110, 115, and 120 strikes.
But here’s the problem. Yes, the dollar value of these puts is high, but so is their delta. They are all in the 90’s, meaning it’s pretty close to just a stock position. A delta neutral player, which basically describes most market makers, would already be either long or short enough stock (or equivalents) to hedge these. Whatever pain or gain was associated with them has already happened.
In other words, they are a non-factor at this point. If AAPL gets back in that range, than they may become relevent. But that’s a very big if, and something that would happen independent of options pain.
If you’re near expiration and near a strike with large open interest and volatility is tame, expect lots of pins and near pins. But I truly would not get carried away with it, it’s just one dynamic that only comes into play when there’s literally nothing else going on.
