There's certainly no one size fits all, but I've watched this over the years and to a great extent, on certain high visibility, low float, easily manipulated stocks with large open interests across all strikes... this is something worth considering. What is Max Pain (Options)? Max pain is a situation in which the stock price locks in on an option strike price as it nears expiration, which would cause financial losses for the highest possible number of options traders. It attempts to explain how, during the last days, the underlying stock prices often cluster around the strike prices to bring losses to the option buyers. Summary Max pain is a trading concept that states that the market dynamics or manipulation can cause the market price of certain securities close to expiration to expire worthless. Max pain works under the assumption that near the expiration date, buying and selling stock options leads to price movements towards the point of maximum pain, or market setters manipulate price indices to gain more from the closing stock price. Using max pain to trade stock options is challenging since the strike price changes frequently. Understanding Max Pain Max pain is a term used to describe a somewhat controversial theory called Maximum Pain Theory, which states that there will be a maximum loss to investors who buy and hold option contacts until the expiration date. There are two assumptions for the occurrence. The first assumption is pegged on price movements, which is due to the legitimate buying and selling of stock options for hedging by traders. During the last days, the index moves towards the strike prices where the option buyer experiences the maximum loss. The second assumption cites manipulation by option sellers such as large institutions that hedge large positions of their portfolios. Since they are large-sized institutions, they can manipulate the index prices, resulting in no obligation on their part to fulfill the contracts, thus hedging their payouts to buyers. Alternatively, the strategy intensifies towards an expiration date, with different groups competing based on purchasing power to drive prices toward a more profitable closing price. About 10% of stock options are exercised, 30% expire worthless, and 60% are traded out. Max pain occurs when market makers reach a net positive position of call and put option at a strike price where option holders stand to lose the most money. By contrast, option sellers may reap the most after selling more options than buying and causing them to expire worthless. The Maximum Pain Theory is somewhat controversial. The theory’s critics are divided on whether the maximum pain behavior of the close stock prices occurs by chance or is a matter of market manipulation. The latter reason raises more profound questions about the oversight of markets. The lack of oversight by the Securities and Exchange Commission (SEC) is attributed to regulatory behavior. Such behavior is influenced by the size of economic benefits from the arrangements, not to mention the covert nature of the influence. Market participants offer bribes to regulators in the form of money or future job prospects. Max Pain Calculation Calculating the max pain is time-consuming arithmetic that sums up the outstanding put and call dollar value of each in the in-the-money strike price. Here are the steps of calculating max pain: Find the difference in strike price and stock price. Find the product of the results and open interest at the strike price. Sum up the dollar value for the put and call at the strike price. For each strike price, repeat the steps. The strike price with the highest value is equivalent to the price of max pain. Using the max pain as a trading tool is complex, given that the max pain price fluctuates hourly or daily. Thus, it is important to note that when the difference between the max pain price and the current stock price bears a large value. The rationale behind such an idea is that there could be a tendency for the stock price to vacillate around the max pain, but until the expiration approaches, the effects may be meaningless. Practical Examples Assume that Company XYZ Limited wants to trade its stock options when options of the stock are trading at a strike price of $51. In such a case, there is a significant open interest on the stock options at strike options between $54 and $55. Ultimately, the max pain price will settle at either of the two prices, since they will render the maximum values of the company’s stock options to expire worthless. In a second example to illustrate the concept, consider Company X with several contracts that traded on its stock, with the majority at a strike price of $50. Suppose that during the expiration time, the company’s stocks were trading at $50. It means that any strike price of $50 would be in the in-the-money, and hence will expire worthless. The idea is that any given security’s max price at an expiration date can be predicted with reasonable accuracy to determine when to sell options for profit. This concept works best under normal trading conditions.
Underlying stock prices often cluster around the strike prices because there are lots of strike prices.
It's not random strikes being discussed,its the strikes with the largest open interest,I.e largest underlying notional.. I don't buy the whole peg manipulation
I love all manipulation theories, but I assume it works in a more quiet environment than what we are currently experiencing. So I am not sure RIOT is a good candidate especially now. https://www.interactivebrokers.com/en/software/glossary/content/glossary/marking_the_close.htm
I'd agree for the moment RIOT is off the candidate list. I'm lining some others up for Monday to put on and track on the journal page.
My thoughts. The +1,-3,+2 structure is good. Micro-managing the position is bad. The pinning concept is a distraction and should be left out when picking stocks.
Thanks for the recommendation! Anyone has opinions on below? Maybe buying a straddle around lunch time in-between the nearest strikes with 0-2 days to expiration? "Stocks such as Apple and MasterCard that often fail to close near a strike price but have very high strike cross frequencies are excellent candidates for certain types of expiration day trades such as long straddles."
My 2.5 cents...Put trades on with however you choose to measure theoretical edge,and take them off when you realize it... If you are a punter,operate within a prudent risk reward framework... If you can mix and match,you are way ahead of the game
I've read through the book a couple of times. With the straddle on expiration day it looks like there are two opportunities. One buying earlier in the day at around 9 AM after the initial theta decay on the open and then looking for the crossing patterns and then again later in the day as you mentioned. Auguen argues that between 2 and 3 if pinning is happening the movement then remains pretty stagnant till the close. So two windows to go long the straddle and one to short it. Another piece was the selling iron butterflies at the pinning strikes on Wednesday's close and taking them off Thursday morning. I had some success last friday buying the 54 straddle in Uber in the morning and selling it for a decent profit about an hour later when the stock moved towards it's low of the range. Am going to look to try this again next Friday as well for the straddle play.