Does max pain work? Why stocks sometimes pin near it

The story people tell

The popular version runs like this: option writers, mostly large institutions, profit most if price settles at max pain, so they push it there. Charts showing a stock finishing a few dollars from max pain get shared every expiration Friday as proof.

There are two problems. The first is that there is no single collective writer who earns the max pain total. Open interest is spread across thousands of accounts on both sides, many of them hedged, and a market maker whose book is delta-hedged does not profit simply because options expire worthless. The second is selection: a chart of a stock finishing near max pain is memorable; a chart of one finishing eight dollars away is not shared.

There is also a definitional trap. Because max pain is recalculated every night from fresh open interest, it tends to drift toward wherever the stock has been trading, since new positions are opened near the current price. By Friday, the number has partly moved to meet the stock rather than the other way round, which makes the final comparison look tighter than any forecast made on Monday would have been.

The mechanism that does exist

There is a credible route by which expiry can draw price toward a heavily traded strike, and it runs through gamma. If dealers are net long options at a strike, they hedge against the move: as price rises toward and through the strike, their long options gain delta and they sell; as it falls, they buy. Near expiry, gamma at the money becomes very large, so those hedging trades get bigger for small moves, and they all push price back toward the strike.

That is pinning, and research on equity options has found that stocks with listed options are more likely to close near a strike price on expiration dates than on other days, with the effect linked to hedging by those who are net long options. Notice what the mechanism needs: dealers net long gamma at that strike. If dealers are net short gamma there, the same hedging pushes price away from the strike instead of toward it.

Max pain does not encode that information. It does not know who is long and who is short; it only knows how much open interest exists. So a strike can be max pain and also be a place where dealers are short gamma, in which case the hedging pressure works against pinning.

Why max pain often looks right anyway

Open interest is not spread randomly. Traders open positions near where the stock is trading, and they choose round strikes. The strike that minimizes total intrinsic value is, almost by construction, close to the centre of that open interest, which is close to where the stock has been trading for the past few weeks.

So if a stock simply stays in its recent range through expiration week, which is what most stocks do most weeks, it will finish near max pain without any force pulling it there. To claim max pain causes the outcome, you would have to show that stocks finish nearer max pain than they would nearer any other level the same distance away. That is the test almost nobody runs.

Our own intraday testing points the same way: a heavy strike that is just sitting there did not draw price in the final hour any more than a random level at the same distance. The version that tested was change, a same-day concentration being built near price late in the session, not a static number computed the night before.

How to use it sensibly

Treat max pain as one summary of open interest for a specific expiry, alongside the call wall, the put wall and the gamma sign at price. If the book is positive gamma near max pain, a quiet, range-bound expiration is a reasonable expectation. If the book is negative gamma, max pain says very little about where the week ends.

And check the date. Max pain is most relevant for the largest expirations, monthly and quarterly, and for the expiry that is actually settling. A max pain number for a monthly contract three weeks out is not describing this Friday.