On Monday, I published a Seeking Alpha article about the impact the theory of maximum pain can have on stock prices. You can reference that article by clicking here. I intend to publish a lengthier update to that article on Monday, as May's options expiration week commences. Price action in Apple (AAPL), however, leads me to jump the gun and provide an update today.
While academic work and other analyses of the theory of max pain render inconclusive results, investors should keep a close eye on stocks that often pin to the strike price that would cause the most "pain" to option contract holders.
On Monday, shares of Apple traded between $346.53 and $349.20, closing the day at $347.60. A look at Apple's recent price history reveals two interesting points: (1) After touching $350 on Wednesday, AAPL appears to be setting up for a holding pattern that could assert itself around $340; and (2) AAPL often runs right after an options expiration day and begins to fall heading into the next one. Price action, courtesy of Yahoo! Finance, since April options expiration shows this trend.
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I have yet to determine what the max pain strike price was for AAPL in April. It would not surprise me if it was $330. Considering the fact that AAPL came down from highs of around $350 in late March to close April's options expiration day at $327.46, lots of people who bought calls on the run to $350 would have been hurt. Call writers stood to benefit.
It's important to note that the theory of maximum pain does not suggest illegal market manipulation. Rather, it's a statistically-based hypothesis. Backers argue that stock prices tend to pin to the options strike price that would cause the most 'pain' for option contract holders.
Interestingly, AAPL's max pain price for May remains unchanged from last week at $340. Here's the most up-to-date chart, courtesy of OptionPain.com.
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Early in Thursday's session, AAPL's chart indicated a breakdown that makes $340 or less appear realistic. AAPL rebounded considerably, finishing the day down $0.66 at $346.57. This type of intraday swing is nothing for AAPL. In fact, it's quite common, particularly on the heels of a meaningful up or downtrend.
It will be interesting to follow the action into next week, particularly on days when tech is up. The last day to trade May options is Friday, May 20th. Of course, things can change in an instant, but, at this point, the movement merits at least one eye. I think it has a better than zero chance of playing out to form with respect to max pain theory.
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(Chart courtesy of Schwab's StreetSmart Edge)
When I wrote about exiting my long position in AAPL, I noted I would swing trade it. it's this type of price action that fueled a penchant for that strategy. It's difficult to call anything "predictable" in this racket, but the way AAPL moves month-to-month comes pretty close to qualifying. If you are an AAPL long, with a close study of its historical price action and chart, you could make up for the dividend the company does not pay and its tendancy to stay range-bound by banking profits on short-term trades that take advantage of the action I outline in this article.
On Monday, I will provide a complete update on maximum pain as it relates to AAPL and other stocks as we head toward options expiration on May 20th. In that article, I will also take a closer look at AAPL's month-to-month price history.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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