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Thread: market indicator ... Max Pain

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    Default market indicator ... Max Pain

    Market Value which will cause maximum pain to options holders when options expire this friday ...





    a real coincidence here that the market took a huge jump upward, but settled at exactly the point of 'maximum pain' for options holders.

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    Veteran Member casaubon1's Avatar
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    Default Re: market indicator ... Max Pain

    Melanie, how is the MaxPain target calculated? I assume it is based on SPX options only, with some weighted distribution of strike prices, and then the target is that value for the index that minimizes the value of that distribution of options? Is there a theory as to why the underlying stock values would move to that position?

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    Default Re: market indicator ... Max Pain

    from

    (snip)"Max Pain is a term used to describe the specific price that a stock can close at on options expiration day in order to lead to the most dollars lost for those who bought options on that stock over the past months. "Everyone loses=Max Pain". Not coincidentally, this price point also leads to the most profit for those who SOLD the options over the last months (usually institutions, market makers, etc.)

    Example: Take a look at the options chain on MSFT

    Notice that for both calls and puts, the Open Interest (# of contracts sold) is highest at a specific strike price. This means that the Max Pain point is that strike price, because if MSFT closes at or extremely near that price on the day these options expire (always the 3rd Friday of the month), then all of those call AND put options will expire completely worthless--PURE PROFIT for those who have been selling them this entire time. Max Pain followers believe that as you get closer to that Friday expiration, the stock will tend to be pulled closer and closer to the max pain level."(snip)

    As you can see, Max Pain can be calculated for any individual stock, or stock index, for which options are bought and sold. When an index is involved, calculating the max pain point involves calculating the options for the individual component stocks with the same weighting factors that the index uses - as well as including the options sold on tracking stocks/etf's for the same index.

    The theory behind the predictions offered by Max Pain analysis (among the tin foil hat crowd at any rate) is that the hedge funds, big financial houses etc. are primarily sellers of options while smaller investors are primarily buyers of options. Thus the hedge funds and big financial houses stand to earn the most profit on their options when, by options expiry friday (which for this month is tomorrow), they can buy and sell enough futures and/or buy/sell/short enough actual shares to push the market price to the Max Pain point. The hedge funds and big financial options then book their options profits on that friday, and the price levels of the stocks and indexes are then free to drift back to 'normal' levels.

    The larger issue behind the Max Pain indicator is the belief (among the tin foil hat crowd at any rate) that there are large financial forces at work behind the scenes that are able to manipulate stock, bond and commodity markets for their own reasons, such that market pricing levels bear less and less correlation to the actual financial health of the US economy and/or particular industry segment / company.

    The reason that Max Pain is the subject of particular attention this week is the huge market pricing moves to the upside which have taken place in the last couple of days, without a whole lot of positive change in economic fundamentals (like Fed interest rate policy) or for that matter political fundamentals to justify those sort of moves (after all rockets are still flying in the middle east)
    ~
    Last edited by Melonie; 07-20-2006 at 05:16 PM.

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    Default Re: market indicator ... Max Pain

    Thanks. Sort of the conspiracy theory explanation of SPX movement. Press seems to be attributing yesterday's run to speculation on Fed policy after BB's testimony. Interesting to see if it also is consistent with the optimization of MaxPain.

    One other dumb question -- who are the "tin foil hat" crowd?

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    Default Re: market indicator ... Max Pain

    One other dumb question -- who are the "tin foil hat" crowd?
    literally speaking ...

    allegorically speaking, the 'tin foil hat crowd' refers to those people who, despite a shortage of 'smoking gun' evidence to prove their existance or their actions are taking place, are of the belief that powerful behind the scenes forces are at work to secretly manipulate markets for their own purposes. Personally speaking, I doubt that some secret agency of the US or Russian gov't (or extra-terrestrials with invisibility cloaks around their orbiting spacecraft for that matter) are attempting to directly affect my thoughts via the broadcast of secret microwave signals (the original genesis of tin foil hats to protect your brain against such signals), but I've been around long enough to see some really strange and otherwise unexplainable s#!t happening in the stock markets, the precious metals markets etc. from time to time.

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    Default Re: market indicator ... Max Pain

    Ah, but the hats are ineffective if the FBI secretly plants radio transmitters in their teeth . . .

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    Default Re: market indicator ... Max Pain

    ^^ "Kent, Kent, I'm talking to you, Kent" LOL

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