Max Pain Theory in options trading suggests that the stock price will gravitate towards the strike price where the highest number of options (both calls and puts) will expire worthless on the expiration day. This phenomenon occurs as option writers, typically institutions or sophisticated traders, adjust their positions to minimize loss, influencing the underlying stock’s price movement.
By identifying the ‘Max Pain Point,’ traders believe they can predict the price direction leading up to expiration. The theory is based on the premise that market makers and large institutions aim to cause financial pain to the highest number of option holders. While not universally accepted, Max Pain Theory offers an intriguing perspective on market psychology and potential price manipulation.