“Let’s pretend I own the entire [AAPL] options chain,” Richard Bloch writes for Seeking Alpha. “What’s the best outcome for me? Either a really high price or a really low price, but certainly not something in the middle.”
“The worst possible outcome for me would be an expiration with AAPL closing at around 560,” Bloch writes. “At that level, based on all my open interest, the intrinsic value of all my calls and all my puts would be worth ‘only’ $2.45 billion.”
Bloch writes, “And that’s the point of maximum pain… Why is this so painful? Probably because those options cost way more when I bought them. After all, these options are expiring, so there’s little time, nor time value left.”
“What’s the ‘maximum pleasure’ (or really, ‘minimum pain’) if I happened to be short all those April calls and puts? The best possible outcome is the same, 560. And the theory of maximum pain relies upon the premise that sellers of options do better than buyers of options – and that collective market action will drive the price to a level where option sellers minimize their pain and maximize their pleasure,” Bloch explains.
“The maximum pain theory is interesting, but I’m not convinced that it does much good when there’s less than a 1% difference between strike prices for a stock like Apple,” Bloch writes. “But I do look at the graphs sometimes. And when you review them for future expirations, thinking in these terms of owning the entire options chain might help you understand how these figures are calculated and what they mean, if anything at all.”
Read more, and see the graphs, in the full article here.
[Thanks to MacDailyNews Reader “Fred Mertz” for the heads up.]