Option Expiration - Max Pain Theory

Discussion in 'Trading' started by JJ2000426, Dec 20, 2007.

  1. Many people probably are familiar with the maximum pain theory. The conventional wisdom is by the option expiration day, the stock tend to trade at a level that minimize the total liquidation value of all options, both calls and puts.

    It is generally true, but not always. If the outstanding options are too low comparing with daily trade volume, probably it does not work.

    But what of the outstanding in-the-money options is a really big number comparing with daily trade volume, is it more likely that the maximum theory will be true?

    Here is a real case. Stock currently trading at $3.70. For December expiration, The only in the money call options are 849 calls at $2.50.

    On the put side, in the money puts include 1061 puts at $5, 3784 puts at $7.50, 523 puts at $10, 7 and 3 at $12.5 and $15.

    So total in the money puts are 5378 contracts, worth 0.5378M shares. Average daily trade volume is about 300K to 500K.

    Do you guys think that because of the huge disparity of in the money puts and calls, the maximum pain theory will push the stock from $3.70 to close the week at $5.00 to $7.50?

    The stock is PAL.
  2. dsq


    why would you waste your time buying an option on a stock that is so cheap?Buying the stock is like buying an option without the pain of decay or time stress...
  3. I am not talking about buying options. I am talking about with such extreme disparity of call and put options to expire on Friday, what kind of impact will it have on the stock price movement.

    Have a look. It's PAL. If maximum pain is true it could be pushed from $3.70 to $5+, quite a gain in two days. It isn't always so cheap, 6 months ago Cramer pitched it at $12.65. It looks like a bottom here.
  4. Check out the "huge disparity":

    <img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=1720978>

    Yup, this stock's gonna pop 35% in two days for sure now! :p
    Please keep the entertainment coming!

    P.S. PAL does NOT trade below book, companies do NOT deliberately manipulate their share price lower right before a secondary offering in order to take in LESS money from the sale (it's the exact opposite), AND no one in their right mind takes investment advice from a guy who puts 95% of his capital in one single stock. Other than that, you're doing great! :D
  5. So is that not a huge disparity? Virtually all calls are out of the money and all puts are in the money. What would happen if the put holders exercise tomorrow to take profit?

    PAL produced $51M worth of metal in Q3 but reported only $36M in sales revenue. In Comparison in Q1 it produced $59M of metal but reported $68M of sales revenue. So of course the Q3 looks bad. But it only means the extra metal will be sold in Q4, boost Q4 profit.

    The metals it produce, platinum and palladium, are in good rally in recent days:

    PAL is indeed trading near or below its book value. Q3's balance sheet shows $166.625M in shareholder equity. Recent secondary offer injected $75M new cash so that brings shareholder equity to $241.625M. Including new shares now PAL has 74.6M shares, at recent low of $3.40 that's a market cap of $253.64, not much higher than the book value.
  6. jj whatever....owned
  7. I see this phucknuckle is continuing the:

    [​IMG] and [​IMG]
  8. plugger


    Oh yes!!!!! If the put holders exercise, the stock will shoot up. And it's not going to stop at 7, I'm thinking more like 12 by Friday. Hell, maybe even 15.

    I heard they discovered a new cure for cancer which involves cold fusion. Just imagine, finding a cure for cancer and solving the world's energy problems. Wow. What a find! And all this from palladium.

    JT is a genius.
  9. Lucrum


    Using BCA software's data and going back 38 months I took the difference between the close of the QQQ for each expiration and Max Pain for that month and came up with the following statistics.

    Differece between expiration Close and max pain of the QQQ

    Average + 0.07
    Median +0.14

    Looking at those two numbers alone gives the impression max pain is worth watching however the maximum/minimum was
    + 3.87 and -6.31
    The standard deviation was 1.97
    The average deviation was 1.38
    and the variance was 3.88

    In short you may be able to come out ahead if your selling OTM options on either side of max pain over a long period of time but as far as using max pain as an aid for directional trades it's all but worthless.

    FWIW someone else on another forum did a similar study going back even farther than I did and came to the same conclusion.
  10. Frank, what do you mean "owned"? It is a fact that there is a huge disparity of PAL's december expiring options, it's a pretty large quantity in comparison to its daily volume.

    So if the maximum pain theory is true, we will see its price pulled from $3.70 to $5.0 or more in just two days.

    Please look up the data of PAL and express an opinion yourself, agree, or disagree, and why. We will know it in two days. So it is a good test of the maximum pain theory.
    #10     Dec 20, 2007