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Know Your Max Pain Level When it Comes to Options Expiration

Stocks in this article: TWTR

NEW YORK (TheStreet) -- Investopedia defines "max pain" as the point at which options expire worthless. The term max pain stems from the Maximum Pain theory, which states that most traders who buy and hold options contracts until expiration will lose money.

According to the theory, this is due to the tendency for the price of a underlying stock to gravitate towards its "maximum pain strike price" -- the price where the greatest dollar value of those options will expire worthless.

I take a little bit of a different approach. Instead of looking for a "pin" point where the greatest number of options expire worthless based on the total dollar value of the options, I find it more helpful to look for a pin where the greatest number of options themselves expire worthless.

Here is an example taken from the April 19 expiration of Twitter (TWTR).

Here is a look at what the TWTR open interest looked like on April 19, the last day of the week to trade the options (note: typically the last day to trade these options is Friday, but markets were closed on Good Friday). You can see that the $45 strike has even more open option positions that could expire worthless. 

TWTR closed that day at $45.01.

How Did That Happen?: Many people think this pinning effect is due to manipulation. That theory is definitely up for debate. I imagine most market makers who are controlling large amounts of stock do have a vested interest in keeping as much premium as they can without having to give up anything in return.

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