Maximum pain for an options chain can show the option trader the expiration date price that will cause the option buyers to lose the most money. The max pain level is the strike price with the highest volume of open contract put options and call options for a set expiration date. The maximum pain price is the specific price where the underlying stock would cause the most loss to the largest number of option holders if the underlying expires there.
The maximum pain theory says that an options pricing chain open interest will move towards and show the max pain price, many times the max pain price will be equal to the highest volume strike price of a put and call option where price will pin on expiration day. This pinning can cause the largest amount of option holders to lose money with the key strike price and all the surrounding out-of-the-money options expires worthless.
The calculation of the maximum pain price level involves adding up the total dollar values of premium for the open put options and call options for all of the in-the-money strike prices.
Many times option writers will hedge their open short contracts with stock of the underlying or other long options to manage their risk exposure. Market makers in the option market will hedge to remain delta neutral and profit from bid/ask spreads and theta decay.
When the option expiration chain date gets closer, option writers must manage their hedges in stock or long options and this hedging activity can show up in option volume and point to the price level they are targeting to be profitable in their short options. Both call and put option writers are trying to hedge and maintain their profits.
Approximately 60% of option contracts are closed out before expiration, 30% of options expire worthless, and 10% of options are exercised by calling the stock or putting it on someone.
Here is a great max pain options calculator through this link at https://www.swaggystocks.com/dashboard/options-max-pain/SPY
On this site you can enter a ticker symbol and it will visually show you the open interest and maximum pain on a options chain.
I have created the Options 101 eCourse for a shortcut to learning how to trade options.
