The February 2014 monthly options expired on Friday 02/21. The closing stock price on Friday was 525.25. The max pain value was 535. Did max pain miss? Yes. But in my opinion it still provided a direction for AAPL.

Max pain is based on the MM rebalancing positions opened to counter option contracts they had to write in order to make a market. This takes effect during the last week of the option contract. So, what happened during that last week?

We can see the history on Yahoo Finance

Date Price Max Pain
Friday 2/14 543.99 $532.50
Monday 2/17 Presidents Day $530.00
Tuesday 2/18 $545.99 $535.00
Wednesday 2/19 $537.37 $537.50
Thursday 2/20 $531.15 $537.50
Friday 2/21 $525.25 $535.00

First, max pain predicted a drop in the price. On Friday 2/14 the stock closed at $543.99 and max pain was at $532.50. Furthermore, max pain continued to be below the stock price until the end of the day on Wednesday. Before the open on Thursday max pain was at $537.50 and the stock had closed at $537.37. This is a 13 cents difference.

A short position would have been the correct trade in AAPL for week. So while max pain failed to get the value exactly, it did indicate a downtreand.

The open interest indicated a close below $540? Take a look at the open interest graph.

AAPL had a large number of call contracts open at $540 (and also $550). Had AAPL closed above $540, all of those contracts would have been in the money. The MM would have to pay on all those calls. Max pain theory says hedging by the MM against that would apply pressure to keep the stock below $540.

This is very much what Travis Lewis advocates. He uses the highest call and put OI as a range of highly probable close values. I believe he indicates that he will sell calls beyond that and collect the premium when they expire worthless. In this case, he could have sold the $545 calls.

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