Max Pain theory in Options Trading is probably one of the newest bust most popular strategies for Options trading. This theory is backed upon the fact that about 95% of option buyers lose money. We have personally traded based on max pain and the success ratio is pretty cool. This article intends to explain max pain theory of options and how to profit from it. Also, we would go through Options max pain calculator excel sheet which can be downloaded from the end of this post.
Max Pain Theory: Definition and Usage
The idea behind Max Pain theory is the fact that Option writers tend to manipulate the expiry price of stock, index or commodity so that they benefit the most out of their positions. Although there is no authentic proof that how they manipulate the prices, yet this theory is widely accepted. As 95% of the options expire worthless and options is a zero sum game, this theory seems very realistic and logical. By definition, Max Pain is the strike price where if the underlying settles on expiry will cause maximum loss or maximum pain to the option buyers. Guess who would benefit from their loss? Yes, its Option sellers. Most of these Option Sellers are large investors / institutions or hedge funds that will hedge their positions and have the ability to manipulate the stock price to suit their open Options position.
There are enormous ways in which you can benefit from Option pain. Basically, max pain tells you the approximate level at which the contract is going to expire. If you know know this level, you can simply write Call options slightly above this level and pocket the premiums on expiry. Similarly, you can write Put options below this level. If you are a conservative option trader you can employ different hedging strategies like Bull Spreads or Bear Spreads.
Options Max Pain Calculator
Max pain is calculated using the Open Interest of options. The calculation is fairly simple and is summarized below:
- List down the different strikes of the option chain along with their open interests.
- For each strike, calculate the profit/loss incurred to the option writers if the underlying expires at that level. This calculation should sum up the profit/loss for put as well as call option at that strike price.
- The strike price at the the loss is minimum is termed as Max Pain strike price.
Automated Excel sheet for Max Pain calculation
We have created Options max pain calculator excel sheet which does all the background calculations and shows the Max Pain strike price. This excel sheet is automated and you need not to manually enter any data into the sheet. Currently this excel sheet supports both Nifty and Banknifty from NSE. When you open the sheet it would throw some warnings which can be safely ignored. The sheet would refresh every 5 minutes.
Below are few screenshots:
Download link for Options Max Pain Calculator
Please see the below link to download Options max pain calculator excel sheet. Mostly everything is self explanatory, but please let us know if you have any queries. Also, send us your feedback on how to improve this sheet.
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