Option Pain Charts for Nifty

Option Pain

There is a Wall Street axiom that says “90% of all the options that are bought and held to expiration will expire worthless”. This means that 90% of the time the people who ‘write’ the option and collect the premium, never get their stock ‘called’ from them or get stock ‘put’ to them. Whether the actual percentage is 90% or something lower is irrelevant to the evaluation of the Max-Pain™ effect.

What Is Option Pain?
Option Pain, also known as Max Option Pain or Max Pain, is based on the theory that since most options buyers lose in options trading, the price of the underlying stock must be manipulated somehow to close during options expiration at a price that results in the most options contracts expiring out of the money. If the Option Pain theory holds, it becomes possible to actually predict the exact price a stock would close at during option expiration through charting the open interest of both call and put options. That exact price is known as “Option Pain” or “Max Pain”.

Assumptions of Option Pain
The definition for Option Pain taken from Optionpain.com is:

“In the option market, wealth transfer between option buyers and sellers is a zero-sum game. On option expiration days, the underlying stock price often moves toward a point that brings maximum loss to option buyers. This specific price, calculated based on all outstanding options in the market, is called Option Pain. Option Pain is a proxy for the stock price manipulation target by the option selling group.”

In this definition, we can extract the following assumptions:

1. “Wealth transfer between option buyers and sellers is a zero-sum game”. This means both parties cannot gain or suffer together. In options trading, when one party wins, the other party loses.

2. “On option expiration days, the underlying stock price often moves toward a point that brings maximum loss to option buyers”. This means that on option expiration day, most option buyers with open positions loses money.

3. “calculated based on all outstanding options in the market”. This means that Open Interest is representative of the number of buyers of stock options.

4. “stock price manipulation target”. This means that stock prices can and are manipulated on option expiration days.

5. ” by the option selling group”. This means that a specialized group of traders exist that manipulates stock prices known as the Option Selling Group.

How to calculate option pain for Nifty

In order to compute the maximum pain price, or the price level that will see the greatest number of options expire worthless, one has to compute the total rupee value of all open contracts. Let’s consider an example using the Nifty and the April 2010 Nifty options, which expire in fourteen more days. To start the Max-Pain™ analysis, list the available spectrum of strike prices and total Open Interest volume for the April’10 Puts and Calls. See the table below

STRIKE
CALL OI
PUT OI
CALL VALUE
PUT VALUE
TOTAL VALUE
410017245026945004511689500045116895000
420014850290050172450004058476500040602010000
4300136600445950359750003608164000036117615000
440019100515050683650003162311000031691475000
45001078008652501026650002721608500027318750000
4600875009919501477450002289558500023043330000
470010040011650502015750001867428000018875855000
480047860029875002654450001456948000014834925000
490035290040192503771750001076343000011140605000
5000573350529115052419500073593050007883500000
5100863650465115072855000044842950005212845000
520020305009787300101927000020744000003093670000
53004233850931795015130400006432350002156275000
54007100100415015024301950001438650002574060000
550052511005085004057360000595100004116870000
560036833501322506209635000260050006235640000
57001108400157350873024500057250008735970000
58002731003365011361695000118000011362875000
5900927501180014020455000014020455000
60000016688490000016688490000

Then calculate the cumulative total value of the current Open Interest positions, as if they are held to the expiry day, over a range of closing prices for the ITM Options during expiry , Nifty

After gathering all of the strike prices and open interest numbers for the April 2010 Nifty options, the next step is to compute the cumulative value of the open interest for both the puts and the calls assuming the Nifty closes at various prices. Here will assume that, at expiration, the Nifty closes at a value equal to each of the nineteen strike prices ranging from 4100 to 6000. The process is done for both the puts and the calls.

For example,

If the Nifty closes on expiry at 4200, then only 4100 call is at the In the money(ITM) option.Then the value of all the in-the-money CALL options is Rs 17245000 [or (100 x 172450)].

This is the value of the options that will NOT expire worthless if the Nifty is at 4200 at expiration(Just an assumtion :) ). From table we can see that the cumulative rupee value of the calls increases as the Nifty moves up in price, but the value of the puts declines as the Semiconductor HOLDRS moves higher.

If the Nifty closes on expiry at 4300, then only 4100 call and 4200 is at the In the money(ITM) option.Then the value of all the in-the-money CALL options is Rs 35975000 [or (100 x 14850)] + (200*172450)].

If the Nifty closes on expiry at 4400, then only 4100,4200,4300 call is at the In the money(ITM) option and rest of the call expires worthless.Then the value of all the in-the-money CALL options is Rs 68365000 [or (100 x 19100)+ (200 x 14850)] + (300*172450)].

this process needs to be continued till the end of the strike prices.. in our case it is 6000. The calculation is little large and lengthy :). Also the same procedure needs to be done to calculate the ITM put values at expiration

Finally after computing CALL Value,PUT Value. The next step in finding the point of maximum pain is to add the total value of the open interest for both the puts and calls across the various prices. In table , the total value appears in the last column. The point of maximum pain occurs where the total value is the least. At that level, the most puts AND the most calls will expire worthless, causing the most pain to option owners. In our example, 5300 represents the price of maximum pain.

Stacked Chart is plotted i.e the sum of the PUT Value and the CALL Value. The point at which the most options expire worthless is labeled and is the point where the overall minimum value occurs (the Max-Pain Point™). It appears to be at the 5300 closing price point.

How Should I Read the Call and Put Chart?
This chart plots the total value of calls (blue) and puts (orange) separately. At a specific price point, if the call value is greater than the put value, the stock price may be manipulated below the strike price, making all call options worthless. If the put value is larger than the call value, the stock price may stop above the strike and make the put options worthless.

What Should I Do if I Hold In-The-Money Options Near Expiration?
You may want to sell the in-the-money option, call or put, one week before the final option expiration Thursday. If you hold these options to the last moment, very likely you will see your options become worthless.

How to Profit From Option Pain
It has been proposed from some investment and options trading websites that stocks tend to move towards the Option Pain level as expiration hour approaches and is most predominant in high volume stocks (these are again claims that have yet to be rigorously tested or proven.). Essentially, if you know what price a stock will end up and when, there is almost an endless number of options trading strategies that you can use to take advantage of it. If the Option Pain level is higher than the stock price right now, you could use a Bull Call Spread by buying the At The Money call options and then sell the Out Of The Money call option slightly above or at the Option Pain price. Conversely, if the Option Pain level is lower than the stock price right now, you could use a Bear Put Spread using the same logic. Naked call write and put write at the strike price slightly above or below the Option Pain price works as well.

Related Readings and Observations

Comments

  1. SOURABH says

    THANK YOU VERY MUCH RAJENDARAN SIR FOR SUCH LOVELY ARTICLE. THIS KNOWLEDGE INCREDIBLE ARTICLE HELPS TO UNDERSTAND COMPLEXITY OF OPTION AND INCREASE OUR KNOWLEDGE…

  2. Viren says

    Rajendaran,

    Very interesting and thank you for all the effort you put in the calculations to arrive at 5300.

    Have you back tested your results and would you be kind enough to share your analysis.

    I have my doubts about this concept of Max Pain succeeding in our markets, as you know that options on the Nifty are sold much more than bought and being predominantly dominated by institutions, the ‘max pain’ calculations may be actually ‘max gain’ for them.

    I like to be proved wrong though, and wish for some more previous results.

    Cheers,

    Viren.

  3. sp mishra says

    thanks rajendran for the informative article on options and the pain in the ***.every month one has to face trading options.

    after trading for a year in options i felt that i am making money a good amount in the first 2 weeks and losing big time in the last two weeks of a month.

    all the calls and puts that i buy are usually rocking , but due to the manipulation of option traders i miss out most of the time.

    i am only alive and kicking as i turn to hedging in the last week.

    however , thanks all the same.

    now can we take it one step further and prepare a simple excel sheet where we can calculate the options pain on a daily basis and find out the trend for high volume and operator active stocks.

    think about it and pls do send me a email. i could have done it myself but i do not know of any website which shows the value and open interest of option calls .

    can u help as the 2 weeks are over and i am looking at the 3rd week with some open positions.

    bye

    spm

  4. Veer says

    Wondeful. We have to keep on calculating everyday because the OI changes everyday.Finally it follows that the concept OI plays the role i.e. increase in price and increase in OI is Bullish etc. etc. Am I correct sir?

  5. TC says

    Hi Rajendran,
    Again…same query !!
    The Option Pain Charts seem to be missing !!
    Any news on when they will be back again??
    Thanks
    T

  6. Prasad says

    Can i get The columns and rows of nifty options somewhere? for e.g

    date Nifty Options put price call price
    22 sept. 6009 2.00 100.4
    23 Sept 5900 “” ::

    It will be very help ful to interprete and analyze.

  7. Anand Sagar says

    How do we calculate the put value or call value in option pain…i could not understand a bit..please help.

  8. richy says

    hi i read your post about max pain. I trying to create my own spread sheet in excel so i can back test this theory with old open interest data. Im have trouble to get the formula correct. Wandering what was the excel formula you used?
    i used =((($B10-$B9)*C9)+((J9*2))) colum B was the strikes, C was the open interest, and J the total value

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