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Research by the Securities and Exchange Board of India (SEBI) shows that in the Indian derivatives market, nine out of 10 traders lose money.
However, there are certain concepts – such as max pain– that can help you limit your losses, if not completely mitigate them.
As the market moved lower in this expiry of July 13th, the max pain for Bank Nifty shifted lower to 44800, as of Wednesday closing, according to the myf&o database. Similarly, max pain for Nifty stands at 19400. This implies the market is expecting options at these strike prices to expire worthless, leading to losses for option buyers.
What is max pain?
Max pain or maximum pain is a theory which states that the price of an underlying, say Nifty or Bank Nifty, will move towards its maximum pain strike price — the price at which the greatest number of options will expire worthless.
The basis of the max pain theory is a generally considered notion in the market that option sellers have a better understanding of markets, and, therefore, better control over option prices, compared to retail traders who are, essentially, buyers of options, said Rahul Ghose, a Mumbai-based derivatives trader and founder of algorithmic trading platform Hedged.
For example, the max pain for Nifty is at 19400 for this weekly expiry. This essentially means that options sellers are expecting Nifty to expire at the 19400 level. If it happens, traders who have bought 19450 call options or 19400 put options would suffer maximum loss as their options would expire completely worthless.
Does this hold?
Like all theories in the market, there are people who believe this works and there are some who believe this does not. There is not much reliable literature available on the theory that expounds its accuracy in the Indian derivatives market.
“In the endless rundown of questionable theories of stock market, the theory of option pain absolutely finds a spot,” write P Govindasamy and R Ravimohan, professors of School of Management Studies, Vels Institute of Science, Technology and Advanced Studies, in a research paper.
“Option pain, here and there alluded to as ‘Max Pain’, has a huge number of people wanting to learn it and most likely an equivalent number of individuals who dislike it strongly. It is to be straightforward that in the long periods of following option pain, it was always unable to bring in reliable returns. In any case, there are strategies ad libitum on this theory,” they add.
To be fair, option pain is a relatively young theory, originating in 2004, according to the professor duo quoted above. Nonetheless, it has found enough takers to be taken seriously.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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Bank Nifty max pain at 44,800; What is max pain in F&O and how does it work? – Moneycontrol
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