Indicator of the week: Maximum Pain

Sounds dangerous doesn’t it?  Maximum Pain?

Maximum pain theory indicates that share prices will gravitate towards the point at which most options will expire worthless.  I’m in no way shape or form an expert at options, in fact I have never traded them.  What I do know is this, options expire every third Friday of the month.  That is the option buyer has until then to exercise his right to buy the equity at the agreed price or the option expires and the seller gets to keep the premium the buyer paid for that right.  Thus this expiration day and the strike price that has the most buyers losing out is called “Maximum Pain”.

Evidence suggests that prices of equities tend to gravitate towards that price.  Whether it is by chance or market manipulation, no one knows.  It’s not something I personally use as a strategy, but I do use it as a confirmation of where I think things are headed.

There are several websites online that handily calculate the maximum pain stike point for you.  The one I use is here:

http://www.optionpain.com/MaxPain/Max-Pain.php

Check it out this Friday.

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