In case you aren’t aware, this week is May expiration week and options on equities for May are set to expire after the market closes today at 4:00 PM EST. On Tuesday, I highlighted a strategy known as the iron butterfly, which can be used when you anticipate the underlying equity to close near a particular strike. In the options world, market makers on the floor of the exchanges will sometimes be short a large number of contracts at a particular strike, and will therefore benefit if those contracts expire worthless (or with very little value). They stand to benefit from taking in more premium at the time the options were sold than when they expire.
When there is a lot of open interest residing at one strike (and we assume this was bought-to-open) stocks tend to gravitate toward this strike or even move sideways for the duration of expiration week. Stocks that are setting up like this for the week can often be “pinned” at what is known as the “max pain strike”—i.e. where option buyers feel the most “pain”.
Take a look at a few charts that I have below. I also included the current open interest configuration for the May series that are set to expire today, 5/17. Take note of some of my comments regarding the charts and how these three names have moved sideways for the majority of the week (all of this is as of the close on 5-16-13). I think that these three equities have a decent chance of pinning.
McDonald’s (MCD) was the example that I sited in my blog post on the iron butterfly, but I think it realistically has a good chance of closing near this level. Not only is the $100 a round, psychological level, but it is also the site of a huge number of both call and put open interest. As a quick refresher, calls expire worthless if the stock price is at the strike or below it on expiration. Puts expire worthless if the stock price is at the strike price or higher on expiration. MCD made a nice move from $100 this week, but sold off a bit yesterday. We could see some added selling pressure that will drive the stock closer to that $100 level.
Blue chip firm Intel (INTC) has been making a solid move along with the other semiconductors. Recently, this strength has slowed, and we can see the slight drop-off in volume at the bottom of the chart. The 24-strike is the site of approximately 55,000 puts and calls, and is the max pain strike for expiration Friday. Also, take note of the huge call open interest that resides almost entirely by itself at the 25-strike. I’ve written before about how huge amounts of call open interest overhead can act as points of resistance. Even if INTC rallies today up to the $25 mark, it could very well be met with resistance, and ultimately retreat back to $24.
Finally, AT&T (T) is another name that is already trading very close to its max pain strike. The 37-strike is home to about 40,000 option contracts. After a recent negative reaction to earnings (noted on the chart), T has been slowing a bit, after posting some solid gains in 2013. This is low-volatile stock in the first place, so chances are that it will not experience much movement between the opening and closing bell today. I like this stock to pin at $37.
Analyzing a stock and its potential to pin at the max pain strike is something that I have always found interesting. The more I have been involved in trading, the more I realize that there are many “games” that other traders and market makers can play— especially in the derivatives market. Gaining an understanding of these types of concepts in trading will come with experience. Good luck out there.