If you've ever had a conversation with a trader just before the Thursday expiry, you might have come across phrases like“ Kaha lag rahi hai expiry?”🎯” or “Iske aas pas close hone ki probability hai”.
On a lighter note, traders often engage in discussions about predicting a precise strike price at which the underlying asset is expected to close on the expiry day. What if we told you that, behind their confident predictions, there is some basic mathematics at work? This blog will explain all you need to know to understand the concept of Max Pain. Let's get started!
What is Max Pain?🤔
It is the strike at which option buyers lose the most money on expiry. Conversely, it is the point of minimum loss for the option seller. In simple terms, it's like a tug of war between option sellers and buyers at this strike price. The option sellers try and drive the price of the underlying towards this strike in order to have minimum pain.
Why use Max Pain📝
Stumped by all the strike prices you see on an Option chain? That’s where Max Pain comes in. Traders use the Max Pain to narrow the range of an underlying and predict the expiry level. Based on the strike price identified, both buyers and sellers can implement endless option strategies and avoid losses.
How to calculate the Max Pain🧮
To calculate Max Pain, list all the strike prices and open interest of both the call and put options of an underlying asset. Now calculate the loss the option sellers will make at each strike, assuming the market closes at that strike. The strike at which the option seller will make the minimum loss is called the Max Pain.
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Want to learn more about Max Pain and its implications? Click here to read a chapter that explains all about Max Pain from our Options Book. Get a deeper understanding of the concept and how it can help you navigate the markets effectively.