Terminology, Trading

Options Expiry and Max Pain

Read an interesting blog post (link here) that highlighted two nuances about options expiry

  1. While options stop trading at 4pm on the 3rd Friday of the month, they technically expire only at 12 noon on Saturday. Brokers have their own policies on automatically exercising options that are ITM.However note that since stocks still continue trading after-hours, what you might think is an OTM position might actually end up being exercised, and if you don’t have enough funds, or if the stock gaps down thereafter, you might be in a whole lot of trouble.

    The learning point here is that you should close out your position or make the exercise decision actively, instead of waiting for the auto-execution by the broker if the outcome is unclear.

  2. Index options (e.g. on SPX, RUT) stop trading on the 3rd Thursday, instead of Friday, and are cash settled based on the opening prices of the constituent stocks on Friday. See here for more information.

Related to options expiry, I also chanced upon a website which calculates the options max pain value. Essentially the theory goes like this:

  • The “market makers” are on the opposite side of the options outstanding (i.e. as reflected in the open interest).
  • As such, the “market makers” will influence the price of the underlying to minimize their payout when the options expire, which is equivalent to causing the maximum pain to the options holders as a group.
  • The price of the underlying that achieves that is known as the “max pain price”.

So I just put in SPY into the calculator and I get a max pain price of $151.50 for SPY (use the Actual Pain value, which I think is more reasonable), which is the target for today (Thursday) based on the theory since the SPY options are expiring today. The SPY closed at 152.20 yesterday. We will have to see how this theory performs later.

Update: SPY opened at 152.33, closed at 152.15, and is now at 151.99.



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