Premium: The Concept of Max Pain in Options

10 comments Written on December 25th, 2013 by
Categories: Options, Premium

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Options are a strange beast. Most options expire worthless, and this has been demonstrated in the US (read: Do Options Sellers Have a Trading Edge?)  If this is true, then let’s make a big assumption. Assume there is a Mr. Market, who is a big force and can move the market. He is an option seller.


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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

10 comments “Premium: The Concept of Max Pain in Options”

Thanks for this.

Did not understand however – if the strike is 6000, and the expiry is 6000, there should be no call or put pain . How have you calculated 600000 call pain

That’s the Put Pain of 600,000. Because higher strike puts have open interest, at 6000 tehy will be in the money…

Sorry for this question – may be basic

I meant Put Pain – so 6000 strike rate – the OI is 1000
How do you get 600000?? Request e.g or a calculation.

Similarly if the strike is 6400, how is the calculation done when the strike and expiry are the same

Thanks for all the super posts- Have subscribed for a year and have read each post twice!

Thanks Mahesh!

At 6000 strike, two puts are in the money. 6200 put and 6400 put. they have OI of 1400 and 800 respectively.

The 6200 put earns Rs. 200. So the OI multiplied by the earning = 1400 x 200 = 280,000.
The 6400 put earns Rs. 400 (since Nifty expiry is assumed at 6000). So same calc = 800 x 400 = 320,000.
Total pain is the sum of these two which is 600,000.

The options at 6000 earn nothing. The calls of 6200 and 6400 earn nothing. So we ignore those.

Thanks!

In the example, when calculating the pain for strike 6200, the OI of 6200 has not been included.

Only the OI at 6000 i.e 500 and 6400 i.e 800 have been taken to calculate the pain. That’s why my question on the calculation

You’re right, because at 6200 the options of 6200 have no intrinsic value. The 6400 put is in the money by 200 rupees, and the 6000 call is in the money by 200 rupees. Thats’ why we take the OI of the 6000 call and 6400 put.

Hope that explains?

Got it!!

Thanks!

Dear Deepak,

The fact that you took “pains” to explain the above query till you finally got an OK from Mahesh puts you in a different league all together. :-)

Its an awesome feeling to realise that there are indeed professionals like you around who have made it their life’s purpose to simplify the world of finance.

More power to you.

Thanks mate :)


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