The phrase quadruple witching brings to mind stories that begin, “It was a dark and stormy night…” or folkloric visions of witches flying chaotically on broomsticks across the brightness of a moon. In the context of investing, quadruple witching also refers to possible chaos but chaos in the financial markets. Such chaos can erupt due to four different types of contracts on financial assets expiring on the same day. The quadruple witching hour is the last hour of the trading session on that day. The question is whether investors can make abnormally robust profits on quadruple witching days due to market fluctuations. If you want to trade off quadruple witching, run your plans by a financial advisor to ensure you don’t end up casting a spell on your portfolio.
What Is Quadruple Witching?
Quadruple witching refers to four days during the calendar year when the contracts on four different kinds of financial assets expire. The days are the third Friday of March, June, September and December. The assets on which the contracts expire on that day are stock options, single stock futures, stock index futures and stock index options. Options contracts also expire monthly. Futures contracts expire quarterly.
Because all four types of contracts expire on the same day, the quadruple witching day usually sees a heavier volume of trading. This is why the reference to chaos is made about this witching day. Market volume is increased partly due to offsetting trades that are made automatically. Volume on quadruple witching days has increased roughly two-thirds of the time since 2005.
On June 18, 2021, a quadruple witching day, a near-record volume of single-stock equity options was set to expire at the end of the day in the amount of $818 billion. As a result, a near-record of single stock open interest of about $3 trillion stood on June 18, 2021. Open interest refers to how many contracts are open during any given point during the day. It is an important metric for traders to watch since a large amount of open interest can move the value of the underlying stock.
Types of Contracts
Quadruple witching occurs when four types of financial contracts expire the third Friday of the last month of each quarter:
Stock Options
Options are derivative securities whose value is based on the underlying financial asset. They give the owner the right to complete a trade involving the underlying security on or before their expiration date at a particular price called the strike price. The owner of the option does not have to complete the trade. If the strike price is below the stock’s current price at expiration, the owner of a call option can exercise the option and turn a profit. If the option is a put option, the owner can make a profit if the current price is under the strike price.
Stock Index Options
Stock index options work exactly like stock options except their underlying asset is some market index like the Standard and Poor’s 500 or the Russell 3000. The owner of the stock index option has the right, but not the obligation, to exercise their option on the expiration date. If the strike price is below the stock’s index’s current price, it may be profitable for the trader to exercise the option. The opposite is true for a put option.
Single Stock Futures
A futures contract on a single stock is a legally binding agreement. Investors agree to buy or sell a contract on an underlying asset at a specified price on a particular date. The buyer is legally required to buy the underlying asset at expiration and the seller is legally obligated to sell the underlying asset.
Stock Index Futures
Stock index futures are similar to single stock futures except the underlying asset is a market index. Investors buy or sell a market index on a future date and at a price that has been locked in. The account is then offset and a profit or loss is posted to the investor’s account. Investors use index futures to bet on the direction of the market to make small, abnormal profits.
Impact of Quadruple Witching on Investors
Investors are concerned about the price volatility of securities on quadruple witching day. Their concern is only somewhat legitimate. Even though the volume of securities traded does increase about two-thirds of the time, there is price volatility only about one-third of the time. The volume of contracts ending and the positions that have to be closed, rolled out or offset can lead to movements in the value of the underlying securities.
Closing a position refers to taking a position exactly the opposite of the position you have. This nullifies your position. An offset is the most common way of closing a position. A rollout of a position refers to closing one position and taking a position with a later expiration date.
There may be global or domestic events on or near a quadruple witching day that impact or even magnify the effect of this day on the broad market. Right before the quadruple witching day of June 18, 2021, the Federal Reserve announced that, due to inflation concerns, it may raise interest rates in 2023. The result was, on that day, the Dow Jones Industrial Average dropped 1.6%, the Standard and Poor’s 500 dropped 1.3% and the NASDAQ was basically flat.
Should investors plan to buy due to these events on quadruple witching days? If you closely watch the market, you may be able to determine which securities may sell-off and jump in to pick up bargains. Proceed with caution and consider getting advice from a finance professional.
The Bottom Line
The quadruple witching days have the potential of causing chaos in the financial markets due to the expiration of the contracts of four financial assets on the same day. The volume of trading during these days, coupled with potential price volatility, can affect the value of investor portfolios. If national or world events happen to collide with these four days, price volatility and trading volume could be enhanced. Investors have the potential to make at least small excess profits through hedging and speculative strategies. The price of the underlying securities of the derivative instruments whose contracts are closing may experience volatility.
Tips for Investing
Trading futures and options is risky and not for beginning investors. If you think you might want to invest in these derivative securities, it would be best to talk with a financial advisor. Finding one doesn’t have to be hard. If you use SmartAsset’s financial advisor matching tool, you can find a financial advisor to your liking. If you’re ready, get started now.
You can use SmartAsset’s investment calculator to enter information about your investments. Enter your planned contributions, the interest rate and time horizon. You will see how much you will have at the end of a time period. Change the assumptions and you can do a scenario analysis to see how much money you will have under different circumstances.
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Source: https://finance.yahoo.com/news/quadruple-witching-day-invest-140023996.html