The investment universe consists of NYSE, AMEX, and NASDAQ stocks with share codes 10 and 11. Stocks with prices below $5 are excluded. Data for stocks is obtained from CRSP, and data for option prices are from the OptionMetrics IvyDB database.
ASSET CLASS: stocks | REGION: United States | FREQUENCY:
Weekly | MARKET: equities | KEYWORD: Predictability, Options Expiration
I. STRATEGY IN A NUTSHELL
This strategy uses the Max Pain concept from options markets to predict short-term stock moves. Stocks are sorted by Max Pain, then longed or shorted weekly based on relative values.
II. ECONOMIC RATIONALE
The Max Pain theory suggests stocks gravitate toward strike prices minimizing total option payouts. Option writers’ actions influence underlying prices, allowing traders to anticipate short-term gains and losses before expiration.
III. SOURCE PAPER
No Max Pain, No Max Gain: Stock Return Predictability at Options Expiration [Click to Open PDF]
Ilias Filippou, Washington University in St. Louis – John M. Olin Business School; Pedro Angel Garcia-Ares, Instituto Tecnológico Autónomo de México (ITAM); Fernando Zapatero, Boston University – Questrom School of Business
<Abstract>
Max Pain price is the strike price at which the total payoff of all options (calls and puts) written on a particular stock, and with the same expiration date, is the lowest. We construct a measure of (potential) Max Pain gain/loss, sort stock prices according to this measure, and find that a spread portfolio that buys high Max Pain stocks and sells low Max Pain stocks generates large, positive and statistically significant returns and alphas. Our results provide strong evidence of stock return predictability at the expiration of the options. We also find that there is significantly higher stock trading volume and order imbalances for these Max Pain gain/loss portfolios. The strategy is not related to reversals of price trends that might have explained initial options volume. The results are especially strong for relatively small and illiquid stocks.
IV. BACKTEST PERFORMANCE
| Annualised Return | 4.91% |
| Volatility | 7.97% |
| Beta | N/A |
| Sharpe Ratio | 0.62 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
