What is Max Pain?
Max Pain refers to a circumstance where the stock value contracts onto an alternative strike price, since it approaches expiration, resulting in financial deficits with as many options traders as possible. It tries to explain why, in recent days, option price values typically concentrate through strike prices, causing option buyers to lose money.
Understanding Max Pain
According to the maximum pain concept, option writers typically hedge the plans they've drafted. Hedging is performed by the marketer in order to maintain a balanced position in the stock. Take into account the market maker's situation if they need to construct an option contract but wouldn't want to take stockholding.
Option writers may attempt to invest in stocks as the option time limit advances in order to push the market towards a more closing price which is beneficial for them, or at the very bare minimum to hedge its payments to option users.
Because the maximum pain pricing might fluctuate daily, if not hourly, employing it as a trading strategy is difficult. The price may well have a tendency to move forward to maximum pain, but the impacts may not have been noticeable until expiration.
Practical Example
Stock HK's contracts are running at a strike price of $58. Meanwhile, there are a number of available interests in HK's options at $61 and $62 strike prices. The maximum pain price would thus stabilize at each of these two numbers since they will result in the greatest number of HK's options expiring worthless.
In a Sentence
- The term Max Pain is used to indicate the stock price situations in the market where the financial situations fluctuate from time to time.