Ouch! Max Pain! And more shocking news!
So first the shocking news! Amazing! Tech is back! Umm, ok, so you're not surprised. Funny how we are all not surprised - but the market trades like it is. Just a few days ago we had the "shocking" news that September retail sales were lousy. And tonight after hours Intel, IBM and Yahoo! reported earnings and GASP! two out of three were great! I heard someone say, "well, when the CEO of Cisco said it, the market didn't believe it. Now they do.." Uhh, ok, but I think we all know to keep a sharp eye on the good working tech stocks.
I don't bet on earnings. I didn't buy any of the above three today: INTC, IBM, YHOO. What I did do, was continue to buy into positions of tech stocks I love. And I picked a bunch in CAPS today too. The networkers we know are working: JNPR, CSCO, CIEN. The high P/E stocks that sometimes trade with tech: NILE, CMG. etc etc
My post from last Thursday was called "FINALLY!" - because tech started to sell off. We had a nice few days. Hope you started lining up your dream positions whether they were in AAPL or BIDU or OMTR or RIMM or CIEN or whatever they are. And I say whatever positions you have been looking for, because like I always say - you have to know the stock, because you have to be able to hold it and to sleep at night, otherwise you'll just sell some day just because "well, it seems high". We've all done it. But how are you going to make any big returns that way? I, for one, just can't buy semiconductors - I don't get the sector. I keep hearing that some semi's are ok, and some are a commodity. Huh? Too confusing. I'll just hold my CIEN and BIDU and whatever I understand..
OK, now for "OUCH! MAX PAIN!"
I don't know if you've heard of "max pain", but I know you've heard of options expiration. This Friday is options expiration. Here's Yahoo's option expiration calendar. So let's say I bought options in MSFT for October. I need to exercise those options or sell them by end of day Friday. (for more detail check out this explanation)
Have you ever noticed that a stock you own seems to be hugging a certain number? It doesn't seem to be trading on the news (higher oil, a breakthrough, whatever) - it just sits there. This is most likely to happen with the largest cap stocks with the most options. This is where Max Pain Theory comes in.
Max Pain is a term used to describe the specific price that a stock can close at on options expiration day in order to lead to the most dollars lost for those who bought options on that stock over the past months. "Everyone loses=Max Pain". Not coincidentally, this price point also leads to the most profit for those who SOLD the options over the last months (usually institutions, market makers, etc.) ..(quoted from here)
So the institutions do the best, save the most money, if the most options expire worthless. So for our example: MSFT. Option interest looks like this (for ease - I'm just posting the call option information):
25.00 - open interest - 5,619
27.50 - open interest - 24,215
30.00 - open interest - 103,827
32.50 - open interest - 68,469
35.00 - open interest - 18,915
So from visual inspection, it looks like the most options traded are around the $30.00 strike. Interestingly MSFT tried to rally today, but closed at $30.32.
To really calculate max pain, you need to run the numbers from calls and puts. Luckily there is a website that does this for you. Check it out - Max Pain Website - put in your ticker symbol, and make sure to change the month to "October" and the year to "2007".
You don't have to make decisions based on max pain, but it can sometimes explain why the stock might be acting differently than you expect. It also might give you a little more time to get into a stock. With a rally expected in tech, we would expect to see MSFT take off tomorrow right? If max pain theory holds, then we should see MSFT hold close to $30 through Friday close of trading. And if you really want to buy into MSFT, you probably have the next three days to do so.
Earnings can really throw these numbers off. Just another tool for your toolbox, or just a curious thing to look at when we're homing in on the 3rd Friday of the month.
It's not an ultimate predictor, especially for smaller stocks with smaller sets of options. For example, for all you ISRG lovers out there you can't type in ISRG to the max pain calculator (which will give you $220 by the way), and assume we're going to see a big selloff after earnings on Thursday. We just don't know - earnings can throw these off, and ISRG is a much smaller stock than MSFT.