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Triple Witching Friday- Coming to YOUR Portfolio on June 18th!

Triple Witching Friday…..what a scary term! Is it the day after Halloween? NO. Is it a hazing ritual for a college fraternity? Not even close.

Well then, what is it?

It is an event that takes place when stock index futures, stock index options and stock options all expire on the same day. Triple witching days occur four times a year on the third Friday of March , June, September and December. It is believed that the term triple witching originates from the three witches in Shakespeare’s play Macbeth. This phenomenon is oftentimes referred to as freaky Friday. More recently, single stock futures have been added to the trader’s arsenal and these securities also expire on the same four dates thereby giving birth to the term Quadruple Witching Friday. Because investors attempt to unwind (close out) their positions prior to contract expiration, the market can be particularly chaotic and unpredictable. Market volatility and trading volume is enhanced. The last hour of these trading days, from 3:00 to 4:00 PM EST, is referred to as Quadruple Witching Hour. This type of volatility is possible as we approach expiration of the June contracts this Friday.

Quadruple Witching Components:

1- Stock Options: A call or put option on a single stock.

2- Index Options: A call or put option on a financial index like the S&P 500.

3- Single Stock Future (SSF): A futures contract with an underlying of one particular stock, usually in batches of 100. There is NO transmission of share rights or dividends.

4- Index Futures: A futures contract on a financial index.

Futures versus Options Contracts:

Covered call writers sell call options and are familiar with options contracts. Let’s define Futures or Futures contracts:

These are financial contracts OBLIGATING the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity (like gas, oil or corn) or a financial instrument, at a predetermined date and price. Some may require the physical delivery of the asset, others are settled in cash. These markets are highly leveraged compared to stock markets. The main difference between options and futures is that options give the holder the right, but not the obligation, to buy or sell the underlying asset on or before expiration, while the holder of a futures contract is obligated to fulfill the contract terms.

Increased volume and volatility: 

Stock options that are exercised, or the underlying stock bought/sold, create large additional volume. With unwinding large volumes of stocks, there is an increase in index arbitrage (the simultaneous purchase of index futures and the sale of a basket of stocks, or vice versa, when the values of the index and the underlying stocks become “out of wack” with each other). Meanwhile, some investors are trying to unscramble whether to, say, buy/sell a position, in options or futures contracts, similar to their current ones (i.e., roll-out the existing contracts) or get into different ones. There is one other reason for the increase in volatility. The composition of the Russell 2000 index, a barometer for small-cap stocks, is reconfigured each June by Frank Russell Co., which created the index. Thus, there is added trading activity in the delisted stocks (i.e., removed from the index) as well as those added to the index. 

Quadruple or Triple Witching Fridays create increased volatility due to greater trading volume and price fluctuations. This is similar in nature to the effect that earnings reports have on equity prices. Volatility means risk and we, as Blue collar investors do everything necessary to avoid risk. Now, I’m not suggesting that we stop selling options four months out of the year. However, would it not make sense to opt for a higher percentage of I-T-M strikes during these months to garner the additional downside protection we may need if that volatility causes our shares to head south?  Whenever a contract period ends with a Quadruple Witching Friday, I tend to have a higher percentage of I-T-M strikes then O-T-M strikes. Another approach to this situation is to unwind your positions prior to expiration Friday or prior to the end of the trading day. I have found that in most of these triple witching months this action is not necessary, but for those looking for a bit more protection, consider one of the above solutions.

Conclusion:

Quadruple or Triple Witching Fridays may create increased volatility due to greater trading volume and price fluctuations. For conservative investors with low risk tolerance, unwinding these positions prior to the end of expiration Friday or selling predominantly in-the-money strikes will help to mitigate this enhanced risk.

Market tone:

The economy continues to show positive signs with the Fed Beige Book survey showing “modest” growth in all 12 districts. Despite a drop of 1.2% in retail sales (in MA), business inventories were restocked by 0.4%. Inventory built in manufacturing, wholesaling and retailing. For the week, the S&P 500 was up 2.5% for a year-to-date return of -1.3%

 With the S&P 500 currently trading below its 50-d and 200-d simple moving averages, we look to guidelines for bullish and bearish moves from this point going forward. Here is a chart showing resistance at about 1050:

S&P 500 50-d sma 6-11-10

Should the value of this benchmark drop below this figure (green line of resistance) on high volume we would have great cause for concern. Looking at a chart reflecting the 200-d sma we look for a breakthrough of resistance:

S&P 500 200-d sma 6-11-10

Should the benchmark break through resistance @ 1107 (red arrow) on high volume, we could get a huge bump up in the movement of the market. There was a nice finishing rally on Friday closing @1091.
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Summary:
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IBD- Market in correction
BCI- Neutral as U.S. economic reports continues to corroborate a steady but slow recovery from the recession but still with concerns over the market volatility. As I complete my final week of dollar-cost-averaging back into the market with ETFs, my plan is to convert into equities and sell the July calls. This is contingent on market conditions over the next week.
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The best in investing,

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

21 Responses to “Triple Witching Friday- Coming to YOUR Portfolio on June 18th!”

  1. admin June 13, 2010 11:06 am #

    Some interesting comments entered late yesterday attached to last weeks article:

    http://www.thebluecollarinvestor.com/blog/theta-time-decay-of-our-option-premiums/#comments

    Alan

  2. Don B June 13, 2010 11:47 am #

    Hello Dave D & Marc B –

    Wow – thanx for the excellent blogs on the BCSI. Serious astute thinking here, which is why I enjoy this forum so much.

    Looks like I shall be holding – for awhile anyway. My 300 shares are enuf to spoil my 2010 track record, but not enuf to shake me out of the call writing “habit”.

    And now its triple/quadruple witching – but it may as well be Halloween! (grin ).

    Don B

  3. Marc B June 13, 2010 12:09 pm #

    For me, my money is much more important than my record.

    I wish you success.

  4. OWEN June 13, 2010 1:44 pm #

    It is not unusual to see large amounts of activity on expiration Friday, especially futures expiration Friday. The people who deal with those instruments are the same people who own the computer program trading systems. If the index is within striking range of a drop below the strike, or a jump above the strike, you often see enough activity to make it come true.

    Something to consider if you are trading options on index ETFs.

  5. Jorge, June 13, 2010 7:02 pm #

    Speaking of stocks that have recovered, check out the chart of MED, ranked #7 this week on the IBD 100.

    Jorge

  6. DaveD June 13, 2010 11:20 pm #

    MED has been unbelievable… it went from around $36, down to $16 then it went as high as $38 recently…

    But, its MSN rating hasnt gotten over 4 in recent months…

  7. admin June 14, 2010 4:17 am #

    Premium members:

    Your weekly stock screen and watch list has been uploaded and is now available for your inspection.

    Alan

  8. admin June 14, 2010 11:24 am #

    ETF stock split:

    IAU a gold ETF announced a 10-for-1 split payable on June 24th. For every share you own today, you will own 10 on the 24th with each share worth one tenth of the previous market value. This will bring down the per share cost from $120 to $12 making it easier for retail investors to buy in lots of 100 for covered call writing purposes. It will also make it more competitive with GLD a popular gold ETF which is priced at about $120 per share.

    Alan

  9. bruce June 14, 2010 5:15 pm #

    Where is this article?

    # Managing Stocks that have Gapped Down
    A gap is a break between prices on a chart that occurs when the price of a stock makes a sharp move up or down with no trading occurring in between. Gaps can be created by factors such as regular buying or selling pressure, earnings announcements, and changes in an analyst’s outlook…

  10. admin June 14, 2010 5:50 pm #

    Bruce and many others,

    I have had several offsite inquiries about this as well. Here is what happened:

    I recently wrote a rough first draft of an article with that title. Instead of saving it, I accidently published it but then immediately reversed it to “save”. Somehow it was picked it up as a published article. I plan to refine and publish this article within the next week or two. Hope this didn’t put you through too much trouble.

    Alan

  11. John June 15, 2010 8:25 am #

    Alan,

    What market conditions are you considering when deciding to sell July options?

    Thank you,
    John

  12. admin June 15, 2010 2:07 pm #

    John,

    I will be looking at several factors including:

    1- support and resistance of the S&P 500 chart as shown above in this artcile.

    2- Momentum of the VIX. Notice how it recently fell from 50 to under 30, an encouraging sign.

    3- Economic news which has generated recent market volatility.

    We can also mitigate risk by selling more I-T-M strikes.

    Alan

  13. DaveD June 15, 2010 10:03 pm #

    Hi everyone…

    Has anyone ever heard of Compound Stock Earnings (Joseph Hooper)?

    I has seen positive and negative feedback on the net regarding their system.

    Would anyone care to voice their opinion of the CSE system?

    Cheers

    Dave

  14. Barry B June 16, 2010 12:25 am #

    DaveD,

    The reason that I follow BCI is because of CSE’s shortcomings. Send me your phone number and I’ll be happy to discuss it with you. My email address is barryb47@gmail.com

    Barry B

  15. Paul June 16, 2010 11:19 am #

    Check out swks. 5% return for the july option (17.50). Nice chart.

    Paul

  16. admin June 17, 2010 8:05 am #

    Premium members:

    Your premium report dated 6/11 was updated last night to include stocks that no longer meet our system criteria. This information may be useful to you as tomorrow is the expiration for the June contracts.

    Alan

  17. admin June 18, 2010 6:10 am #

    Institutional interest:

    Three stocks on our premium watch list that have been getting a lot of institutional interest are:

    LZ
    ROVI
    SWKS (See Paul’s comment # 15)

    Alan

  18. admin June 18, 2010 10:13 am #

    Premium members:

    This weeks report on the top-performing ETFs has been uploaded to the resource/download section of your premium site. Look for “Top-performing ETFs dated 6-18-10.

    Alan

  19. DaveD June 19, 2010 12:58 am #

    Hi Alan

    Some questons which I have for you are…

    1) What are your thought of stocks that DO meet BCI system criteria, but at some same time show a chart that has had a very dramatic run up. For example APKT. This charts pricing action just headed for the moon and has gone into uncharted territory. Would you say to trade this stock would be more speculative/risky?

    (note: This would probably explain why one can get nearly 5% on selling an ATM july call on this stock.)

    2) When looking for candidates to trade would you ever consider stocks that DO NOT meet system critia. For example, STEC. Ths stock was at $40+ some months ago and was probably on many people watchlist. Its fundementals look ok except RS rating and it only gets a 4 on MSN. The chart in no way meets system criteria. But, this stock seems like good value. What are your thoughts on fallen giants such as this one? Do they ever find a place in your brokerage account?

    Thanks Alan

    Dave

  20. admin June 19, 2010 11:51 am #

    Dave,

    Excellent questions. My responses:

    1- APKT is a stock currently on our premium watchlist. When I look at the chart, I see a stock that appreciates in value then consolidates. This pattern continues to repeat. It is a cc writers dream pattern. Your concern that what goes up may come down is valid. But the signs are all positive at this time. I usually ride these as long as I can perhaps selling some I-T-M strikes to hedge my bet.

    2- STEC: A stock like this will rarely find its way into my portfolio. I would rather have Derek Jeter at shortstop than some player who used to be his equal but got hurt and is rehabbing in the minors hoping to make it back to the “big show”. I find that more times than not, when I (used to) veer from my system criteria, I lost. My advice is to find a system that you are comfortable with and stick to it. There is nothing wrong with improving on that system but veering from it for no good fundamental, technical or common sense reasoning seems to be an accident waiting to happen.

    As an aside, I do have some accounts where I take more risk but these are for naked options and are small and capitalized with cash that others may take to Atlantic City.

    Alan

  21. marc b June 19, 2010 11:55 am #

    @ Dave B – I am obviously not Allan, but here is my take.

    APKT – The reason that the options are so pricey is because of the move in the stock creating higher volatility. The chart does look good. The P/E is way to high for my liking. They just had a couple of major shareholders sell some positions, but this is not necessarily bad or unexpected after a run up. I am personally mediocre on this stock.

    STEC – Something stinks about this stock. Since mid September last year it has been in a serious downtrend. Even after the large gap down in early November it has been making lower highs and lower lows. The earning have beat estimates, the P/E is good, they are in a good industry with solid state drives and memory. So why is it trending down…..? The following should shed some light:

    Roy Jacobs & Associates Files Class Action On Behalf Of Purchasers Of STEC, Inc. Securities
    March 4, 2010
    Roy Jacobs & Associates announced that it has filed a class action complaint in the United States District Court for the Central District of California on behalf of purchasers of the common stock of STEC, Inc. during the period from November 4, 2009 through February 23, 2010, alleging claims for securities fraud pursuant to the federal securities laws. The Complaint was filed against STEC and its Chief Executive. The complaint alleges that on November 3, 2009, the Company represented in a conference call that EMC’s inventory of the Company’s SSD products was affecting the Company’s sales, but that this problem could be ameliorated by energizing sales force efforts and increasing consumer education about SSDs. In fact, however, the problem was not a lack of sales force effort or consumer knowledge about SSDs, but consumer resistance to purchasing the ultimate product due to its cost, performance, and flexibility of use.

    I hope this helps your decisions.

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