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If you have been in the stock market for a while, you must have heard of many theories like option greeks, implied volatility fluctuation, and of course, max pain theory to name a few. Most of the theories in the market are new as the concept of options itself is very new in comparison to the history of the stock market itself.
These different theories demand multiple data points for analysis and the traders require a suitable set-up with a predefined risk appetite to be able to make the most out of these theories in practicality.Some theories work for a few while others work for a different set of traders. Having that said, let us know about max pain theory in detail in this article and then you can decide whether this suits your style of trading or not.
So let’s begin!
Key Takeaways
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The strike price at which option buyers suffer the greatest combined loss at expiration is known as the max pain.
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It is calculated using the aggregated open interest of call and put options.
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Traders use it only as a reference and not a standalone strategy, as they are not always reliable indicators; maximum pain levels frequently serve as expiry-day magnets.
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As market open interest fluctuates, values also fluctuate.
What is Maximum Pain Theory?
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Max pain is the financial situation that is looked at from the perspective of option sellers or option writers. It is determined based on the volume of open interest at different strike prices of live option contracts.
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As per this theory, Max Pain strike is the price where Option Buyers (Holders) suffer the maximum aggregate loss, which inherently means Option Writers (Sellers) gain the maximum profit. Sellers want the price to expire at this level.
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Therefore, this theory suggests that the price of the stock will ultimately move towards the price at which maximum pain for sellers is present and one can use this to create buying and selling strategies.
Decoding Max Pain
The concept of the max pain theory is that if the underlying asset’s price stays locked in with the strike price, options traders, especially the call and put sellers, can lose big money. Max pain is the price at which the most open options contracts are standing. It is called open interest. It is the price that would cause the most number of option holders to lose money at expiration.
The concept of max pain refers to the idea that most traders who bought and are holding options contracts until their expiration might lose money. And since more than 80% chances are that the option sellers will make money, the max pain theory gets some validity.
Also, read What is Option Trading here.
How Does Max Pain Theory Work?
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The maximum pain theory explains that when the price of an underlying stock rises, it tends to reflect the number of worthless options.
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As the options expiration approaches, call and put writers will attempt to drive the price of their shares higher to capture more of their payouts.
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The maximum pain theory states that option writers will hedge their contracts to avoid making a loss.
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About 60% of options are traded out, and 30% of them are worthless. The remaining 10% are exercised.
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The maximum pain theory is a controversial topic. Critics believe that it is a result of market manipulation or a matter of chance.
How to Determine the Point of Maximum Pain?
Max pain point takes a lot of time for calculation yet it is a simple process to calculate the same. It is computed by aggregating the value of the put and call options outstanding for all the strike prices.
It is the addition of open interest outstanding on the call and put side of the option chain data found on the website of the National Stock Exchange. It can be computed in the same way for both stocks and indexes.
Following are the steps involved in the computation of max pain points.
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Select a Strike Price: Choose the strike price (e.g., ₹150) as the hypothetical expiry price.
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Calculate Loss for Calls at that Strike: For every call option above the selected strike (e.g., ₹155, ₹160), calculate the loss to buyers by multiplying the Open Interest (OI) by the difference between the strike and the hypothetical expiry price.
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Calculate Loss for Puts at that Strike: For every put option below the selected strike (e.g., ₹145, ₹140), calculate the loss to buyers by multiplying the Open Interest (OI) by the difference.
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Aggregate Loss: Sum all call and put losses for that strike price.
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Identify Max Pain: Repeat this process for all strikes; the strike price with the highest total aggregate loss is the Max Pain point.
That strike price is the point where the options traders will have the maximum pain of bearing the monetary loss.
Complications in determining Max Pain
The max pain price can change in real-time, and it can also be a bit challenging to use as a trading tool. However, it’s sometimes valuable to note that the current stock price and the maximum pain price are significantly different.
Another problem could be that after taking so much effort you calculate the point of max pain but when the stock price goes to that point, there will not be the impact you are looking for since the expiry is far. This strategy would be helpful only when the expiry is closer.
Understanding it with an Example
Let us assume that there is a stock ABC that is currently trading at Rs. 145. And as per the max pain theory, the highest aggregate open interest of call and put options is at the strike prices of Rs. 150 and Rs. 152.50.
So as per the Maximum Pain Theory, the stock price on the date of expiry is likely to end closer to either of these strike prices otherwise there would be a maximum loss to options buyers if the price closes significantly away from the max pain.
Limitations of Max Pain Theory
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The max pain value changes frequently as open interest shifts, making it an unstable indicator for predicting expiry levels.
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It does not account for sudden market events, news announcements, or broader economic triggers that can move prices unpredictably.
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The theory assumes option writers influence price direction, which may not hold true when market volatility is high or when large traders take opposite positions.
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It overlooks market sentiment, liquidity conditions, and intraday momentum, reducing its reliability.
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Because of these factors, Max Pain should only support a broader analysis and never be used as the sole basis for trading decisions.
The Bottomline
The concept of the max pain point hasn’t been around for a very long time. It is considered a relatively newer concept if other theories and strategies are to be compared. The usage of this theory is more popular amongst traders, especially those who write options and investors who hedge their cash market positions using derivatives.