The Strike of Pain is the strike price with the lowest In-the-Money value for both calls and puts on a given stock for a given expiration date. This is the strike where the long option traders will lose the most money and the short option traders will gain the most value. The Strike of Pain is calculated by taking the open interest of the various In-the-Money strike prices multiplied by the amount that the call or put is ITM. The ITM values are added together, and the strike with the lowest monetary value is the Strike of Pain. The Strike of Pain calculation is based on the theory of Max-Pain(tm) developed by BCA Software.
The Strike of Pain calculator is now available in the Calculator Tools section on the PowerOptions suite of tools for stock option trading.
This calculator will help an investor analyze the Strike of Pain for any stock in any given target month. To calculate this value, simply go into the calculator tools, select Strike of Pain calculator, then enter the stock symbol you are researching and select the target month you wish to calculate. The calculator will then show you the monetary values and bar chart interpretation of those values.
Why is this important?
It is believed that stocks will have a tendency to gravitate to the Strike of Pain on expiration day. There is evidence that this tendency exists, but there is still debate on whether this is caused by market forces or by mere chance. It is important to note that such events such as market upheaval, price momentum, breaking news or extreme earnings reports will negate the Strike of Pain value. It is also important to note that the Strike of Pain price is more reliable within the last week until expiration. The Strike of Pain value for a 6-month out target month may be inaccurate as the open interest can drastically change between now and the 6-month expiration date.
How is the Strike of Pain calculated?
As mentioned above, the Strike of Pain is based of the theory of Max-Pain(tm) developed by BCA Software. This theory takes the value that an option is ITM if the stock was trading at a different strike. That value (for the calls or puts) is then multiplied by its open interest. This value for all ITM calls and puts is then added together. The strike that reflects the lowest ITM value is the Strike of Pain. Let’s look at a brief example:
XYZ is trading at $24.50.
We would then look at the Full Call and Put Chain for the nearest month that would show the Open Interest:
|Call Strike||Call OI||Put Strike||Put OI|
The Strike of Pain Calculator will quickly analyze the total ITM value at each strike price. For example, if the stock was trading at 17.5 all of the calls would be OTM. However, all of the put strikes (excluding the 17.5) would be ITM. The 20 strike put would be $2.50 ITM, the 22.5 put would be $5.00 ITM, the 25 put would be $7.50 ITM and so on. To determine the ITM Value of the 20-strike put if the stock was trading at $17.50 we would multiply the 20 put Open Interest, 23, times $2.50 (the amount the put is ITM). This step would be repeated for the rest of the ITM puts and then all the values would be added together.
If the stock was trading at $25, the 22.5 call would be $2.50 ITM, the 20 call would be $5.00 ITM, and the 17.5 call would be $7.50 ITM. Conversely, the 27.5 put would be $2.50 ITM and the 30 put would be $5.00 ITM. Again, the ITM values would by multiplied times the corresponding strikes Open Interest and the call and put ITM values would be added together.
The strike price with the lowest total ITM value is the Strike of Pain. This is the strike price that the stock may have a tendency to gravitate to at expiration.
To access this tool on PowerOptions simply log on to your account and click the Calculators tool on the main Tool Menu. Select Strike of Pain Calculator from the Calculator Menu. You will then be prompted to enter in the stock symbol you are researching and a target month.
Not a member of PowerOptions? Simply direct your browser to www.poweropt.com and click the 14 Day Free Trial SignUp link on the home page. This will give you a free 14-day free trial to PowerOptions, with full access to the Strike of Pain calculator tool and all the patented search and analysis tools available on the PowerOptions suite of tools.
[tags]max-pain, max pain, strike of pain, stock option trading[/tags]