What is MaxPain or Options Pinning?

Investopedia defines maxpain as: the point at which options expire worthless. The term, max pain, stems from the Maximum Pain theory, which states that most traders who buy and hold options contracts until expiration will lose money. According to the theory, this is due to the tendency for the price of a underlying stock to gravitate towards its “maximum pain strike price” – the price where the greatest number of options (in dollar value) will expire worthless.

I take a little bit of a different approach. Instead of looking for a pin where the greatest number of options expire worthless based on the total dollar value of the options, I find it more helpful to look for a pin where the greatest number of options expire worthless by themselves (Read here for a better explaination). Many people think that this pinning effect is due to manipulation. That theory is definitely up for debate. I imagine most market makers who are controlling large amounts of stock do have a vested interest in keeping as much premium as they can without having to give up anything in return. However, I believe that most of the time pinning is  actually due to the market mechanics of buying and selling options.

When calls or puts are purchased, there has to be a seller. Most of the time the seller is likely a market maker. Selling those options carries risk to the market maker and in order to hedge that risk they either sell short or buy the stock outright in order to maintain a delta neutral position. As the stock fluctuates in price the market maker will continue to sell short or buy more stock to remain neutral in his or her position. As expiration approaches and options begin closing out in higher frequency, the market makers rebalancing (buying and selling of the stock) pressures the stock to a certain price point or “pins” the stock. The higher the open interest on a stock, the larger the volume of stock the market maker hedges with and the greater odds of pressure being put on the stock on expiration day. Hence, the higher beta, more liquid momentum stocks are more prone to pin on expiration day.

The most frequent type of pinning you will see is a stock closing where the most amount of options expire worthless (as opposed to where the greatest dollar amount expires worthless as mentioned above). Sometimes looking at the open interest throughout the week, especially on Friday morning can help you determine where a stock will pin. However, the calls and puts of a stock that trade on expiration day can shift the open interest and thus, anticipating where it will pin has its limitations.

Of course, stocks don’t always pin and often other factors will play a larger role in where a stock closes on expiration day. These factors include, earnings releases, news events, large volume based on accumulation or distribution of a stock, and the overall market conditions. And finally, often the options market will affect a stocks closing price in ways other than a typical “pin.” To understand those ways better read the following two  previous posts of mine:

How Options May Have Contributed to Thursday’s Sell-Off

and

How One Strike Can Act as a Magnet During Option Expiration – TWTR

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