by Ian Harvey
The phenomenon of a quadruple witching is a relatively new innovation in the market place. Before the days of single stock futures, a triple witching hour would take place on the third Friday of each month that wrapped up a quarter. There was also the phenomenon of a double witching, which would usually involve stock market index futures and either stock market index options or stock options that were scheduled to expire.
In providing a name for this type of market event, the use of the term witching hour is based on folklore regarding a short period of time when those who practice witchcraft were said to be especially powerful and active. Since the expiration of these four types of contracts exerts a great deal of influence on market performance as the trading day comes to an end, the term is generally thought to be both appropriate and descriptive.
A day on which contracts for stock index futures, stock index options, stock options and single stock futures (SSF) all expire.
Quadruple witching is when contracts for stock index futures, stock index options, stock equity options and single stock futures expire.
On these days.....
.....usually results in increased volatility.
Although futures and options generally share simultaneous expirations on the third Friday of every month, quadruple witching days only occur four times a year.
This happens once every quarter, on the third Friday of March, June, September and December.
The last hour of these trading days, from 3:00 to 4:00 p.m. EST, is referred to as the quadruple witching hour.
Quadruple Witching days, also known as Quad Witching, are the four days in a year where the combined effects of derivative traders exercising their in the money options and taking delivery on their futures contracts as well as traders practicing arbitrage made Quad Witching one of the most turbulent and heavily traded days of the year. Quad witching is one of the most important days to take note of in options trading.
Traders and investors need to bear in mind that a change in ”trading strategies” may be necessary to benefit fully from these “witching” days.
Quad Witching occurs as 4 different types (hence the term "Quadruple") of derivative instruments reach their final trading day on the very same day. In the US market, the final trading day for stock options is every third Friday of each month while the final trading day for single stock futures, options on index futures and certain index futures occurs every third Friday of the quarter. The combined expiration of these four derivative instruments creates the Quadruple Witching day.
Quadruple Witching only begun after 2001. Prior to the trading of Single Stock Futures in 2001, there was only Triple Witching where stock options, index futures and options on index futures expire on the third Saturday of every quarterly month.
Before single stock futures were added to the mix in 2002, the day was known as “triple witching,” owing its name to the three witches of Shakespeare's “Macbeth.”
The day also owes its name to all the wild volume and volatility that historically takes place in derivatives markets as well as the broader market as investors on both sides of each trade buy and sell securities. For that reason, it's also known as "Freaky Friday."
Over the last couple years, however, trades have been unwound earlier in the week, leading to fewer wild swings on quad witching day itself, said Nate Peterson, senior derivatives analyst at Charles Schwab.
Market Reaction and Investors Actions
As quad witching approaches, and these contracts get set to close, investors begin to sell off their positions. The trading gets spread out during the days before as investors sell positions in "bits and pieces", employing certain exit strategies, in an attempt to take advantage of moves in the markets.
As stocks move in relation to index futures, and in relation to each other, investors are getting out of the part of the position that is most profitable at the moment.
For the last two years, volume in futures and options contracts was 30 percent to 50 percent higher on the Thursday before quadruple witching Friday.
Any increased volume, or volatility (which occurs as investors hedge on either side of the trades), are, however, unlikely to lead to big market moves.
On the actual quad witching day, and especially during quadruple witching hour, many investors attempt to unwind their futures and options positions before the contracts expire. This activity frequently includes repurchasing contracts and closing out position market capitalization's.
Quadruple witching days are usually accompanied by considerable volatility in stock and derivative prices, as well as increased trading volume. As a result, investors can anticipate and plan for the potential effects of these relatively turbulent trading days.
Due to the combined effects of exercise, delivery, hedging, arbitrage as well as speculative options trading and futures trading activity during Quad Witching days, the most obvious effect is a dramatic increase in trading volume.
In fact, it has been documented that in 2007, both stock and options trading volume during Quadruple Witching days rose by about 55% to 60% more than the daily average for the year. Even though there might be increased amount of volatility in certain stocks during Quad Witching, the overall stock market action does not look significantly different from a normal non Quadruple Witching day.
The simultaneous expirations generally increases the trading volume of options, futures and the underlying stocks, and occasionally increases volatility of prices of related securities.
Extrinsic value of further month options may be slightly higher than usual on the Thursday prior to Quad increased amount of trading. Due to the increased intraday volatility, options traders holding longer term options positions using trailing stop loss or contingent orders may also experience unnecessary stop outs.
More complicated factors such as Delta, a derivative of options contracts, representing the time until expiration, are also traded and constitute additional positions which must be closed on a Quad Witching day.
Alas, it becomes clear why the talking heads on business television and traders on the floor expect anything other than "business as usual" on a "witching" day.
More often than not, the market will have a positive week on those quadruple witching weeks.
Best of Trading,
Director of Stock Options Made Easy
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