Option chain analysis: Maximum pain theory and practical Implications:

Option chain analysis: Maximum pain theory and practical Implications:

If you will talk about Option pain theory, very rarest of people ,you will come across who are very well familiar with this concept.,although idea of this term was coined in mid of 2004.

But any of the theory,wheresoever being applied, it has to make money for you and has got to have practical implications.

I have noticed this theory if used with two more indicators, works wonderfully well.

Option pain theory required you to be well versed with concept of Open interest.

In any of the strike price segment ,when people started noticing that 90 % of strike price most of time ending as worthless ,hence it came to know that option sellers are real kingmakers , who are making money.

Now here considering this theory as true , we can substantiate some facts which will be testified with practical results.

At any point only one party can make money i.e either the option buyers or option sellers, but not both. From the above statement, it is clear that the sellers are the ones making money.

If option sellers tend to make maximum money, then it also means that the price of the option on expiry day should be driven to a point where it would cause least amount of loss to option writers.

If point 2 is true, then it further implies that option prices can be manipulated, at least on the day of expiry.

If point 3 is true, then it further implies that there exists a group of traders who can manipulate the option prices, at least on the day of expiry.

If such a group exists then it must be the option writers/sellers since it is believed that they are the ones who make maximum money/consistently make money trading options.

Now it is apparent that there exists one point at the time of expiry where there will be lease amount of pain to option writers and maximum amount of pain to option buyers and as a trader we have to pick up that point only.

I have jotted four broad steps, which can make us reach to maximum pain at which options buyer will get a hit.

1)    Quantify first of all a broad expiry level, since market has had sideways huge momentum since from 10250 to 9550 level ,we have to keep out domain broad..

2)    Now screen up till Thursday a narrow range of expiry between 10100 to 9700 and calculate at each strike price amount of loss an option writer(both call and put writer will have ,if market happens to expire on that range

3)    Add up the money for both call and put and focus on that strike price where loss looks very less to option writers as this is the probable point of expiry, where writer will have least loss and buyer will have maximum pain.

Now please undergo this excel, by this excel I have assumed one scenario of 9900 expiry likewise we have to assume two more expiry scenario as 10000 and 10100 and calculate maximum loss to call and put option writers and add up them for each expiry.

Strike price	Call OI	PUT OI	Money lost by 9700 PE writer on respectice expiry	Money lost by 9800 PE writer on respectice expiry	Money lost by 10000 PE writer on respectice expiry	Money lost by 10100 PE writer on respectice expiry	Money lost by 9700 CE writer on respectice expiry	Money lost by 9800 CE writer on respectice expiry	Money lost by 9600 CE writer on respectice expiry
9500	160650	2301600
9600	198900	1400775							106402500
9700	354675	1584600		na			70935000
9800	794400	1090425		0				79440000
9900	836850	867975	0		0			0
10000	1737825	637050			173782500	0
10100	1324650	298800			264930000
10200	1366875	85725			410062500

.this is one scenario we have to calculate also for 10000, 10100,don worry ,if we will have readymade excel formulae then we won’t have much issue in calculating.

Because it’s just from understanding perspective that I have used three strike price but in reality at least ten strike prices are to be taken both way and cumulative call and put loss and overall value is to be calculated.

This way when we reach to least amount of money lost by option writers, that may be point of expiry.

Most traders use this max pain level to identity the strikes which they can write. In this case, since 9900 is the expected expiry level, one can choose to write call options above 9900 or put options below 9900 and collect all the premiums.

Now the most crucial ,since introduction of weekly expiry ,each day due to many happenings market closes at some different point ,so I prefer to choose one common day say Monday to calculate the closing nifty and adding up buffer 2.3% to each side, like in this case if we take 2.3% of 9900 in each side it happens to be 10170 and 9670, hence make option writing accordingly.

This buffer you will have to take because we cannot be 100% sure and abide on one data only.

     messege on comment box ,where the points are not understandable.