Uncertainty remains, the markets are lower and volatility is increasing with this week’s options expiration approaching.  There are several interesting option terms that are often discussed during options expiration week.


Maximum Pain – This is the theory that secuirities will close on expiration day at the strike price that causes the most amount of pain to both call buyers and put buyers.  Surprisingly enough, the point of maximum pain for options buyers is often correlated to the point at which an underlying security will close the option expiration trading day.  For this reason, some traders specifically analyze and set up new option trades around that magical point called maximum pain.  There are several algorithms for computing the maximum pain strike price, but the general idea is to find the highest open interest among the various strikes of calls and puts.  Here is today’s view of the SPY ETF (Models S&P 500) option chain for February.

maximum-pain-at-expiration

From the image above, the CALL strike with the highest open interest is at 83.  The PUT strike with the highest open interest is 80.  The highest combined total open interest for both CALL’s and PUT’s is at the 80 strike. (154,591 + 43,277).  By some maximum pain algorithms, the S&P is likely to close on Friday at 800.

Pin Risk – This is the theory that says securities will sometimes close option expiration days very close to an available strike price rather than at some point in between.  On options expiration days, many option traders must face the decision on whether to ROLL their options to subsequent months.  Option sellers (i.e. covered call writers or calendar spread players) face the decision of whether to let out of the money options expire worthless, or buy them back or roll them if they risk closing in the money.    As an example, consider Apple (symbol AAPL) which exhibited an intraday trading range today from 94.28 to 97.04, and closed at 94.53.  The 95 Strike CALL options went from being out of the money to $2.04 in the money, and closed out of the money.  If this were expiration Friday, many option players would have to decide whether to roll options or take a chance that they may close unexpectedly in the money, or even pin near or exactly to a specific strike price.