How and Why Max Pain changes/moves?

Max Pain Theory:

The theory of options pain stems as a corollary to the belief – “90% of the options expire worthless, hence option writers/sellers tend to make money more often, more consistently than the option buyers”.

Now if this statement is true, then we can make a bunch of logical deductions –

1. At any point only one party can make money i.e either the option buyers or option sellers, but not both. From the above statement, it is clear that the sellers are the ones making money.
2. If option sellers tend to make maximum money, then it also means that the price of the option on expiry day should be driven to a point where it would cause least amount of loss to option writers.
3. If point 2 is true, then it further implies that option prices can be manipulated, at least on the day of expiry.
4. If point 3 is true, then it further implies that there exists a group of traders who can manipulate the option prices, at least on the day of expiry.
5. If such a group exists then it must be the option writers/sellers since it is believed that they are the ones who make maximum money/consistently make money trading options.

Now considering all the above points, there must exist a single price point at which, if the market expires, then it would cause least amount of pain to the option writers (or cause maximum amount of pain to option buyers).

If one can identify this price point, then it’s most likely that this is the point at which markets will expire. The ‘Option Pain’ theory does just this – identify the price at which the market is likely to expire considering least amount of pain is caused to option writers.

How to calculate Max Pain/Option Pain:

1. For each strike prices, calculate loss to option sellers on calls and puts side if the stock or index expires at that particular strike price
2. Add the value of loss from calls and puts side, which is called as Max Pain Data
3. Now the strike with Minimum value will be your Max Pain/Option Pain Strike and that is where the stock/index will expire.

You don’t have to do the calculation manually, You can download the option pain calculator from the description section of the below video in youtube.

Why Max Pain Moves?
So whenever Open interest changes, there will be change in the pain value. If there is a significant change in open interest, then max pain will shift from one strike to another. Watch the video for more detailed information.