Max Pain and Options Expiry

What is Max Pain

Max Pain is the price at which the total loss for option buyers is maximized, or equivalently, the price at which option sellers' total profit is maximized at options expiration.

In other words, it is the price where the combined intrinsic value of all call and put options is minimized. At this price, the greatest number of options expire worthless.

The name "Max Pain" comes from the fact that this price inflicts maximum pain on option buyers.

---

Max Pain Theory

Core Hypothesis

Max Pain theory suggests that option prices tend to converge toward the Max Pain price as expiration approaches.

Why Does This Convergence Occur

In the options market, sellers (writers) are typically market makers or large institutions. They:

1. Sell options and collect premium
2. Trade the underlying asset (BTC, etc.) for hedging
3. Adjust hedge positions as expiration approaches
4. This adjustment process pulls prices toward Max Pain

This is less about intentional manipulation and more a natural result of hedging activities. However, some argue that large sellers intentionally guide prices toward Max Pain.

---

Calculating Max Pain

Calculation Method

1. Calculate the total intrinsic value of all call options at each strike price
2. Calculate the total intrinsic value of all put options at each strike price
3. The strike price where Call intrinsic value + Put intrinsic value is minimized = Max Pain

Simple Example

If BTC is currently at $100,000 with the following options OI:

Calculate the total amount that would need to be paid to buyers if expiration occurred at each strike price. The strike price with the minimum total is Max Pain.

Actual calculations are automatically provided by platforms like Deribit, Laevitas, and Coinglass.

---

Accuracy of Max Pain

Empirical Observations

Opinions are divided on whether Max Pain actually influences prices.

When the effect is observed:

• Expiration dates with very large options OI (monthly/quarterly expiry)
• When the market is ranging without a clear trend
• Effect begins 1-2 days before expiration

When the effect is weak:

• During strong trending markets (trend overpowers Max Pain)
• Expiration dates with small options OI
• When major news/events coincide with expiration

Practical Application

Max Pain is best used not as a price prediction tool but as reference information about areas where price might be drawn. If there are support/resistance levels near Max Pain, the importance of that price zone increases.

---

Market Effects on Options Expiration Day

Expiration Day Volatility

Large options expirations (month-end, quarter-end) can increase price volatility.

Pre and Post Expiration Patterns

1-2 days before expiry:

• Hedge adjustments tend to pull price toward Max Pain
• Volatility may temporarily decrease
• Gamma squeeze risk (when ATM OI is very high)

Immediately after expiry:

• Hedge positions unwound → selling/buying pressure dissipates
• New trends can form
• After mass option expiration, prices move more freely ("unpinning")

Pinning

A phenomenon where price becomes fixed at a specific strike price on expiration day. This occurs at strike prices with concentrated OI. Sellers' hedging activities create an effect that keeps price pinned to that strike.

---

Options OI Analysis

Interpreting OI Distribution

Examining the options OI distribution across strike prices for a specific expiry reveals market participant expectations.

Call OI concentration zones:

• If price rises above this strike, a large number of calls become in-the-money
• Sellers' hedge buying can accelerate the rise (gamma squeeze)
• Conversely, this strike can act as resistance

Put OI concentration zones:

• If price falls below this strike, a large number of puts become in-the-money
• Sellers' hedge selling can accelerate the decline
• Conversely, this strike can act as support

Gamma Squeeze

When price breaks through a strike with concentrated call OI:

1. Call sellers buy the underlying asset to hedge
2. Buying pressure pushes price higher
3. More calls go in-the-money → more hedge buying
4. Chain reaction causes rapid price surge

The GameStop (2021) event was a prime example of a gamma squeeze. Similar phenomena can occur in crypto if BTC options OI is sufficiently large.

---

Put/Call OI Ratio

Put/Call Ratio by Expiry

If put/call ratios differ across expiries, it indicates the market has different short-term versus long-term outlooks.

---

Combining with Other Indicators

Max Pain + Futures OI

If liquidation heatmap clusters exist near options Max Pain, the probability of price converging to that zone increases.

Options IV + Derivatives Funding Rate

When options implied volatility spikes while futures funding rate is also extreme, it signals that the market expects significant movement while being excessively biased in one direction.

Expiry Schedule + Macro Events

When large options expirations coincide with FOMC, CPI releases, etc., volatility can be maximized. On such days, reducing position sizes or strengthening hedges is prudent.

---

Summary

Max Pain is the price at which total losses for option buyers are maximized, and prices tend to converge toward this level on expiration day. Options OI distribution analysis can identify potential support/resistance zones and gamma squeeze possibilities. Market volatility can increase on large expiration days. Use Max Pain as reference information rather than a price prediction tool, and always combine it with other derivatives indicators and technical analysis for comprehensive judgment.

Next article: Derivatives Risk Management - Principles of Surviving Traders