In the initial days of following Option Pain, I was never able to make money consistently. However, overtime I found methods to improvise on this theory to suit my own risk appetite, and that yielded a decent result.
Later in the chapter I will discuss this as well. You can take cues from this chapter and decide for yourself which camp you want to be in. The origins of Option Pain dates back to So, in a sense, this is still a very young theory. 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.
Here is how optionspain. On option expiration days, the underlying stock price often moves toward a point that brings maximum loss to option buyers. This specific price, calculated based on all outstanding options in the markets, is called Option Pain. Here is a step by step guide to calculate the Max Pain value. At this stage, you may find this a bit confusing, but I recommend you read through it all the same. Things ill get clearer once we take up an example .
Step 1 List down the various strikes on the exchange and note down the open interest of both calls and puts for these strikes.
Step 2 For each of the strike price that you have noted, assume that the market expires at that strike. Step 3 Calculate how much money is lost by option writers both call option and put option writers assuming the market expires as per the assumption in step 2.
Step 5 Identify the strike at which the money lost by option writers is least. This level, at which least amount of money is lost by option writers is the point at which maximum pain is caused to option buyers. Therefore this is the price at which the market is most likely to expire. Let us take up a very simple example to understand this. I have made a note of the open interest for both call and put options for the respective strike.
Remember when you write a Call option, you will lose money only if the market moves above the strike. Likewise, when you write a Put option you will lose money only when the market moves below the strike price. Therefore if the market expires at , none of the call option writers will lose money.
Which means call option writers of , , and strikes will retain the premiums received. At expiry, PE writers would lose points. Since the OI is , the Rupee value of loss would be . The PE would lose points, multiplying with the Open Interest, we get the Rupee value of the loss. So at this stage, we have calculated the total Rupee value loss for option writers at every possible expiry level. Let me tabulated the same for you . Now that we have identified the combined loss the option writers would experience at various expiry level, we can easily identify the point at which the market is likely to expire.
As per the option pain theory, the market will expire at such a point where there is least amount of pain read it as least amount of loss to Option sellers. Clearly, from the table above, this point happens to be , where the combined loss is around or about The calculation is as simple as that. But in reality there are many strikes for a given underlying, especially Nifty. Calculations become a bit cumbersome and confusing, hence one would have to resort to a tool like excel.
For all the available strikes, we assume market would expire at that point and then compute the Rupee value of the loss for CE and PE option writers. Once you calculate the total value, we simply have to identify the point at which the least amount of money is lost by the option writer. The bar graph would look like this . As you can see, the strike is the point at which option writers would lose the least amount of money, so as per the option pain theory, is where the market is likely to expire for the May series.
Now that you have established the expiry level, how can you use this information? Well, there are multiple ways you can use this information. Most traders use this max pain level to identity the strikes which they can write. In this case, since is the expected expiry level, one can choose to write call options above or put options below and collect all the premiums.
In the initial days, I was very eager to learn about Option Pain. Everything about it made absolute sense. I remember crunching numbers, identifying the expiry level, and writing options to glory. But shockingly the market would expire at some other point leaving me booking a loss and I wondering if I was wrong with my calculations or if the entire theory is flawed!
So I eventually improvised on the classic option pain theory to suit my risk appetite. Here is what I did . The results were much better when I followed this method. Unfortunately, I never tabulated the results, hence I cannot quantify my gains.
However if you come from a programming background, you can easily back test this logic and share the results with the rest of community here. You can download the Option Pain computation excel. The Put Call Ratio is a fairly simple ratio to calculate. The ratio helps us identify extreme bullishness or bearishness in the market.
PCR is usually considered a contrarian indicator. Meaning, if the PCR indicates extreme bearishness, then we expect the market to reverse, hence the trader turns bullish.
Likewise if PCR indicates extreme bullishness, then traders expect markets to reverse and decline. To calculate PCR, all one needs to do is divide the total open interest of Puts by the total open interest of the Calls. The resulting value usually varies in and around one. Have a look at the image below .
Needless to say, this is a generic approach to PCR. What would really make sense is to historically plot the daily PCR values for say 1 or 2 years and identify these extreme values.
For example for Nifty value such as 1. So you need to be clear about this, hence back testing helps. You may wonder why the PCR is used as a contrarian indicator. You may come across many variants of this some prefer to take the total traded value instead of OI, some even prefer to take the volumes. We have discussed close to 15 different option strategies in this module, which I personally think is more than sufficient for retail traders to trade options professionally.
Some of the best strategies are simple , elegant and easy to implement. The content we have presented in both, Module 5 and Module 6, is written with an intention of giving you a clear picture on options trading what is possible to be achieve with options trading and what is not possible.
We are working toward the same, please stay stunned here for regular updates. Why there is no pdf version for option strategies. Would be great if you could put content in major Indian regional languages like Telugu, Tamil etc.
Request you conduct any kind of finance programms, shows, investor progrmms frm zerodha. May be even less than 10,Sometimes as less as 5.
Though premium will be less , Success rate will be high. What was your experience? Can you please upload PDF files of module no. This would make it easy for everyone to access the module on the go. Thanks for wonderful work you all are doing. Namasthe Sir Plz update all modules in telugu language and coming modules also. Thank u for your great work. Hi, In Nifty option chain the strikes start from to , should we calculate all the strikes OI of both Call and Put to calculate option pain?
Technically you should calculate from the start to end but then we know the liquidity is not much, hence we could ignore these strikes. You can calculate the Max Pain value on any day but I just prefer when there are 15 days to expiry. Sir, Thanks a lot for the simplified option course. I think few more things may be added to make it complete. Items like Call butterfly, strip strap, covered call etc as you promised may please be included.
When we will get detail;ls on pair trading. Every chapter has an excel model attached which shows the working. Suggest you scroll down to download the link. Sir, I hv opened a zerodha account recently. I want to know does zerodha hv any software of updating OI of banknifty option different strike price where live data of OI for calculating option maximum pain in the excel sheet.
Well, accuracy is quite high but the money you make is very very little. Someone once said its like picking up a dime in front of a road roller! Karthik bro can you start commodity,currency module and pause this option strategy module. Eagerly waiting for your modules on those chapters. It generally gives a sense of where the smart money sentiment lies, nothing beyond that honestly.More...