How to trade options using Max Pain Theory?

Options Max Pain Theory suggests, “On option expiration day, the underlying the price of the underlying settles at a point that brings maximum loss to option buyers.”

This is just a assumption which is vaguely based on Pareto Principle.

The Maximum pain for an option buyer is The maximum gain for the option seller. So Maxgain and Maxpain is the same thing which is often confused because of different marketers sell max gain term as some holy grail. But, pause for a moment and think of the core assumption. Now comes the interesting part!

The Maxpain Straddle Strategy

Entry Strategy:

Do a Short Straddle at the strike price of current max pain.

Click here to see Nifty Options Max Pain | Click here to see BankNIFTY Options Max Pain

Now, If you see the max pain sheet from the above link, the maxpain of NIFTY is at 9450. (At the time of writing this note. It will keep changing.)

So the trade “as per the theory of maxpain” should be Sell 9450CE Sell 9450PE. Now, As you can see in this payoff graph, You will be not in the loss as long as NIFTY trades between 9200-9800.

Exit Strategy:

Now, We talk about risk management! It will vary on how you approach.

Exit Strategy Method 1: Like, in this case, if NIFTY touches 9200 or 9800, just cut the trade!

In the above image you can see the initial trade taken. The net premium we received in this trade is 191.85+370.95 = 562.8 points. So we will close the trade if the loss is 562.8 points.

In the below you can see the closure of the trade and start of new trade. We will discuss about the “start of the new trade” properly in the Method 2.

Anyways, the red lines are there to hide the trades which are not as per this strategy.

The most important part of this maxpain theory which we always tend to forget is –

The maxpain is a value that constantly changes as market moves and PE and CE get traded.

So, it is not a holy grail that of something like – If maxpain is at x now it will be at x till the contract’s end. This is the utmost important thing to note!

Exit Strategy Method 2: Here is another approach of % based stop loss. It decreases the net drawdown of the strategy significantly.

Step 1: Sell at the strike price when max pain is.
Step 2: If the net loss is more than 50% of the total premium, close the trade, and follow step 1.

Q. When it touches 9200 or 9800 do you cut the entire trade of just the PE( touching 9200) or CE( touching 9800) accordingly?
A. You cut the whole trade and take the whole trade again. I posted an example as you can see above with Bank Nifty.

So, it is all about how you approach it.

But in days like Thursday, when OI change is rapid and there is huge OI built-up, maxpain is a powerful thing to observe. Many times it happens that, The underlying makes a sharp move towards the Maxpain strike price at the time of nearing of expiry!

The Correct Approach of Understanding Maxpain

How ever, in Unofficed, We have a completely different approach to the Maxpain Theory.

Instead of looking at where the maximum pain to option buyer and where the maximum gain to the option seller happens, what if we look at the “range” where option seller doesn’t make the loss?

So how do you get the range? Let’s revisit our NIFTY Maxpain page.

Do you see Options Writers’ Gain ?

  • So, if NIFTY expires at 6600 immediately, Call seller people will get 217246605 INR in total.
  • Put Seller people will lose -9065842488.
  • Net Loss will be -8848595883

You can see it has been chalked out for each strike price in the same manner. The below graph just plots the net Profit/Loss of Option Sellers if the spot settles there and then.

You can easily see the range where the Option Sellers (Smart Money, as per our assumption) will make money if the underlying (in this case, NIFTY) settles.

In this case, it is 9150-9750 (As of now, We are discussing!)

The math will look easy but if you try to do it yourself by hand. It is quite a quite tough thing. If you’re a nerd, I will suggest you do it by hand as I did. You will love it.

The Maxpain Strangle Strategy

In this case, We will bet on the same range by selling a Short Strangle by selling 9150PE and 9750CE.

The most fascinating fact – If you sell 9450 PE and 9450 CE, You are getting a similar range almost right?

So, Selling a Short Strangle based on the Ranges as discussed above and Selling a Short Straddle on the Maxpain strike price yield almost similar break-even points. (in layman language, it gives similar range where our trade will end in profit)

The premiums are automatically getting adjusted in such a beautiful, majestic, and mathematical manner.

Now, you know what to enter the Short Strangle as well as when to enter. The risk management will vary as per your modification. You can close the trade if the 9150 and 9750 breaches. And, Then Rebalance again.

Anyways, Let me show you a payoff graph of this short strangle. We prefer to short strangle mostly because of the sheer banality of the profit distribution. It is a uniform profit between the range. While in short straddle it is pretty asymmetric as You make the highest profit at the strike price where the straddle is sold and the profit keeps decreasing the more far you move from it!

When the new margin benefit kicks in, We will look to replace Straddle with Ironfly and Strangle with Iron condor. If you want more different ways of trade management like The Method of Delta Hedging or You want to explore the ins and outs of Iron Fly and Iron Condor, feel free to check out the Theta or Newton Course.

Stocks Maxpain

You can also apply similar rules for Stocks Options.

This Dashboard shows Maxpain and relevant details of all Stocks along with their liquidity.

DTE means Days to Expiry. You can see Maxpain of every stock and index here.

But, You need to remember the core of the theory that, Maxpain Changes !! It is not the alchemy you’re looking for. But it is definitely an underrated tool that works far better than overrated tools like moving average.

Collapse Comments

Excellent explanation of the touted holy grail . Is there an associated presentation of calculation of Probability of Profit (PoP) for strangle and straddle as their payoff are quite different . Based on risk profile and passivity individual investor can pick option . Also is there a good time range to enter this position – how many days before expiry. Weekly or Monthly which is better suited etc. Thanks for sharing this knowledge

How to use Max Pain Deviation to predict the direction of Breakout - Unofficed June 20, 2020 at 7:08 pm

[…] How to Trade Using Max Pain […]

At what time trade to be initiated? Is it intraday or positional strategy?

Amit Ghosh (Administrator) April 28, 2023 at 3:46 pm

Anytime. The maxpain shows the maxpain of that immediate time. But the best recommended frame is Friday End as positional trade.

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