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.
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.
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:
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: