------------------------------- From an SI post -------------------------------
To:Joseph Silent who wrote (59650) From: At_The_Ask Saturday, Nov 16, 2002 10:56 AM View Replies (1) / Respond to of 76187
I'm going to chime in for mish here for a minute and try to give him a break. If you first want to learn about max pain and how it works you need to learn a little more about the fundamentals of options and how they work from the pov of an option seller, and especially a market maker in options. You need to understand your greeks and how they all fit together, particularly you need to know about delta hedging. I'm not an expert on option pricing either but I'll try explain what I think I know. If you really want to understand pain then I would suggest studying option pricing and hedging strategies.
Max pain is not a slam dunk carved in stone phenomenon that always works everytime. Sometimes they win and sometimes they lose. If a certain issue has been well below pain for a month or so and it looks like a lot of puts are going to go out in the money it may be a safe bet that an attempt will be made to get that issue close to max pain in the two weeks or so before options ex. If it has already been delta hedged against further movement away from max pain then that creates a lack of selling pressure and perhaps even concentrated buying by option sellers or "they\them-the boys or whatever".
Modern option pricing models call for a certain offsetting position to be taken in the underlying whenever a call or put is sold. Call buying creates buying pressure in the underlying while put buying causes option writers to sell some. If the underlying moves further towards an in the money position additional purchases or sales of the underlying must be innitiated by the option seller as determined by complex mathematical formulas which I do not understand.
What I believe happens in highly optioned issues is that the delta hedging may actually create a fair amount of the supply\demand of the underlying issue at a given price and when supply dries up the issue will rally\sell off. Like I said perhaps even concentrated buying by hedge funds who target these situations or the option writers may also help it along. Also if an issue is heavily putted then it's a safe bet that it is heavily shorted also. Whenever there are victims in the market there is oppurtunity. Squeeze out the shorts and you make money, nothing mysterious about that. Max pain for IBM in oct was 65 or 70 a week or two before opex if I remember correctly and the issue was seventy five at opex. This is an example of how maxpain failed and delta hedging actually propelled the issue in the opposite direction as call sellers were forced to buy.
Let me know why you feel 24.5 is better than either 24 or 25. [Remember, I am not talking about Mr. Big Hand swinging stock price up from below or above etc to kill all strike 24 Calls and all strike 25 Puts etc. I am merely talking about the standard definition].
It doesn't make any difference. If you understand what precisely a call or put is then you will understand why. On or around op-ex day there may be buying or selling of the underlying issues by those who are pretty sure they will get exercised to prepare in advance of that event.
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