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 (March 20th next month), June, September and December. It is believed that the term triple witching originates from the three witches in Shakespear’s play Macbeth. This phenomenon is oftentimes referred to as freaky Friday. More recently, single stock futures have been added to the traders 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.
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:
A financial contract 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.
Conclusion:
Quadruple or Triple Witching Fridays create increased volatility due to greater trading volume and price fluctuations. This is similiar 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? In last week’s article, entitled Selecting the Best Strike Price, I spoke about laddering of strikes. 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.
Last Weeks Economic News:
As promised, President Obama has hit the ground running regarding the economy. Congress reached an agreement on and passed the economic stimulous bill geared to creating or saving 3.5 to 4 million jobs. The Treasury Department introduced its new bank-rescue plan. This initiative has three prongs:
1- Inject capital into certain banks.
2- The FDIC will establish a Public-Private Investment Fund of $0.5 tillion to $1.0 trillion to invest in banks’ bad loans and other troubled assets.
3- Commit another $1.0 trillion to support a Consumer and Business Lending Initiative targeted to small businesses, consumers, and auto-finance loans, as well as commercial mortgages.
In addition to this mega-news, the trade deficit narrowed by 4.0% and January retail sales increased by 1.0% from the disappointing December figures, for its first gain in seven months.
For the week, the S&P 500 declined 4.8% for a year-to-date return of -8.1%.
Industry in the Spotlight- STEEL:
One of the things I do to maximize my profits is to be on the alert for up and coming industries. These are groups that have been out of favor but making a big comeback. The market is cyclical, stocks are cyclical and so are their industries. Over the past few months I have mentioned Schools, Gold, Security and Coal as some of the industries falling in favor with the institutional investors. Today I am highlighting the Steel Industry. Although the technical grade of this group is a D, new institutional dollars have been flowing into these stocks for the past few months. Currently this group is ranked in the 92nd percentile in terms of new institutional money flowing in. Below is a chart of this industry wherein you can clearly see a rebounding group:
STEEL INDUSTRY- 2-14-09
Three of the better performers in this industry are STLD, NUE, and SID. Although these equities do not meet our system criteria at this time, I plan to keep a close eye on them, and much like President Obama, hit the ground running when they do.
Note: Thanks to all for your kind emails regarding the calculations I started to provide on the comments link of these articles. I will continue to post at least one per week of both initial option sales and/or exit strategy calculations. Bear in mind that the ESOC will do these for you, but understanding the thought process behind the math will make us all better and more savvy investors.
Regards to all,
Alan
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Alan,
I’ve been watching steel as well. I still hold STLD in my portfolio…from a long time ago (while still following another system before I learned your wonderful techniques). Cramer seems to be pushing, so I used one of the chart types on stockcharts.com…”perfcharts” to compare the relative performance of STLD, AKS (which I owned in the past), and NUE. As it turns out, NUE appears to be performing better than the other two and may be the pick of the litter when things turn around. I’ll have to go through the complete analysis once that happens.
Any update as to when you will be releasing the updates IBD methodology? By the way…I had my first double in a long time with EBS this month. For the last two weeks, EBS was the number one stock on the IBD100.
The best,
Barry
Hi Barry,
I will send out an update package to all those on my mailing list once the IBD website enhancement is official. It is currently in Beta-testing and although I don’t anticipate more changes, I want to be certain. One thing I can promise is that stock scanning from this site will be easier and just as accurate as the current IBD checkup page.
Congratulations on hitting the double with EBS (an exit strategy for newbies). This is a stock that is in the portfolios of many Blue Collar Investors (including yours truly). Perhaps you can share with us the % return you will have earned by contract end. Selecting the greatest performers in the strongest industries and then increasing those returns via exit strategies is what the younger generation refers to as “sick”.
Thanks for your comments on the Steel Industry. Your feedback is always welcome and respected on this site.
Alan
Alan,
I bought EBS at $24.91 (net of commissions) and sold the Feb $25 for $1.25. Last week i bought back the call for $0.30 for a 3.81% return. I then waited a few days and sold the Feb $25 again for $.70. If uncalled, the second return will be 2.81% and 3.17% if called. So the total return if uncalled will be 6.62% and 6.98% if called by Friday’s close. I think that this is a good example of exit strategy management as the system teaches.
The best,
Barry
Barry,
Great job! 6.62%…dare we annualize that 1-month return?
To those of you just starting out in this wonderful world of cc writing, the other choice with this stock would have been to sell the $22.50 call since options trade in $2.50 increments up to $25 strikes. That would give us a smaller ROO (option profit) but significant downside protection.
Selling the $25 strike is, in essence, selling an A-T-M strike which ususally gives the greatest option return but offers little or no downside protection or upside appreciation.
Currently the stock is trading at $25.07 so the $25 strike is looking like a brilliant decision.
Thanks for sharing,
Alan
HOLIDAYS RECOGNIZED BY THE STOCK MARKET:
With the markets closed today, I felt it would be useful if we all had the dates for future closings for the remainder of this calendar year:
STOCK MARKET HOLIDAYS- 2009
All Major US Stock Exchanges
New Year’s Day January 1, 2009
Martin Luther King, Jr. Day January 19, 2009
Washington’s Birthday (Presidents’ Day) February 16
Good Friday April 10, 2009
Memorial Day May 25
Independence Day *** July 3rd
Labor Day September 7
Thanksgiving Day *** November 26
Christmas Day *** December 25
Early Closings:
*** The NYSE and NASDAQ will close trading early (at 1:00 PM ET) on Friday, November 27, 2009 (the day after Thanksgiving) and Thursday, December 24, 2009. Amex will end trading (1) for those products that normally cease trading at 4:00 p.m. at 1:00 p.m. and (2) for those products that normally cease trading at 4:15 p.m. at 1:15 p.m. The AMEX will start accepting orders for after-hours trading at 1:15 p.m. and all eligible orders will be executed by 1:30 p.m.
Time value on our option premiums will be slightly less during contract periods with market recognized holidays.
Alan
Email question from Roy D.:
You may have covered this question in your book or blog, but… is there a minimum volume of option trading that you look for in a stock before making a decision to buy/write the stock/call option? (I do note your reference to reviewing the option chain for a security as part of your overall selection process.)
Thanks. Roy
My response:
Over the years, I have found that because of the nature of our system, scrutinizing option volume is not critical. Remember, we are only selling options on equities that trade at least 250,000 shares/day. Furthermore, we are selling options near the current market value of the stock and 1-month options at that. Finally, if I see a large discrepency between bid/ask prices, I will move on to another stock/option because exit strategies would be difficult to initiate. After trading 50-70 contracts/month for the past 10 years, I can’t think of one time that I couldn’t close an option position at a decent price. Thanks for an astute question.
Alan
DLTR Exit Strategy:
Two weeks ago, I posted a rolling down exit strategy I used for DLTR eventually selling the 2/35 call and generating an additional $516 profit in my account using this strategy.
Today the stock closed @ $34.18. Since there is only 3 days until expiration Friday, and rolling down does not return favorable results, the only exit strategy possible would be to “convert dead money to cash profits”. To buy back the $35 call would cost $45 per contract. The reason I chose NOT to do this is that the stock was up .50 today in a severly down market day thereby showing unusual strength. My course of action was therefore no action at all.
Alan
Alan
Rolling Out Exit Strategy- EBS
Since this site has mentioned EBS several times over the past few weeks, I’ll use it as our example. Bear in mind that this equity is scheduled to report earnings on March 5th, so I WOULD NOT SELL OPTIONS until after this date. In reality, I sold the $22.50 call this month and would allow the option to expire and the shares assigned. For demonstration puposes, let’s assume no ER and we decide to do a rolling out exit strategy (figures as of Tuesday’s closing prices).
Current price of EBS is $24.20
Buy-to-close the Feb. 22.50 call costs $2.15
Sell the March $22.50 call generates $3.10
Total profit is $95/contract (310 – 215)
1-month profit is 4.2% (95/2250)
Downside protection is 7.6% (2420 -2250/2250).
This means that we are guaranteed a 1-month return of 4.2% as long as our stock price does not decrease by more than 7.6%.
All these calculations are done for you by the ESOC but understanding the thought process behind the numbers will make us all better investors.
Alan
Alan,
In your DVDs you mention that strike prices are listed in 5 dollar increments. I have noticed some option chains with strike prices in smaller increments like $2.50. Please explain.
Thanks for all your help.
Brian
Brian,
In general, most options trade in $5 strike increments. There are , however, some exceptions:
1- Up to the $25 strike price, options trade in $2.50 increments.
2- Over the $200 strike price, options trade in $10 increments.
3- Contract strike prices are effected by stock splits and corporation mergers and acquisitions. For example, if a stock splits 2-for-1, a $25 strike price will become a $12.50 strike price. For information on contract adjustments, save the following link and simply type in the stock ticker symbol:
http://www.cboe.com/tradtool/contracts.aspx
Alan
Alan,
Will you be attending the Trader’s Expo this weekend in Manhattan at the Marriott on B’way and 47th? I plan to be there on Saturday and would love to buy you lunch. Let me know if you’ll be attending.
Barry
HMSY:
One of the most actively traded stocks today is HMSY. It reported earnings and the market had a favorable reaction to that report.
This is a stock already on my watchlist but I didn’t purchase it for the sale of options this month because of that very report.
Now that the ER is behind us and the fundamentals appear solid, it may be a candidate for next month. I’ll do my due-diligence over the weekend to make sure it meets all the criteria of our system requirements.
Alan
DLTR final results:
For the past few weeks I have been posting the statistics on a rolling down exit strategy I executed for DLTR. I generated an additional $516 into my account using this exit strategy. Yesterday the stock closed @ $35.18. .18 above the strike price I rolled down to. That means I could have earned an additional $54 (18 x 3) for the sale of the 300 shares I own. Therefore, I benefited by $462 (516 – 54) by instituting an exit strategy that took me under 5 minutes to perform. This is a great example of what exit strategies can mean for your portfolio.
Since this stock has broken down technically and there is an upcoming ER next week, this equity will not be eligible for my portfolio this contract period. Over this weekend my shares will be sold for $35. I will keep DLTR on my watchlist as the ER may turn things around technically.
Many exit strategies will have happy endings like this one.
Alan