Quadruple Witching

What Is Quadruple Witching?

The term quadruple witching refers to the date on which certain derivatives contracts expire simultaneously. This happens with four different types of contracts, including stock index futures, stock index options, stock options, and single stock futures. Quadruple witching dates happen four times a year on the third Friday of March, June, September, and December. Market activity on these days is typically highest during the last trading hour as traders try to move on these contracts.

Understanding Quadruple Witching

As noted above, quadruple witching refers to a date when four different types of futures and options expire on the same day. These four contracts are stock index futures, stock index options, stock options, and single stock futures. When they expire, investors must make a move by adjusting their positions or closing out the contracts.

Quadruple witching is like triple witching, which is when three out of the four markets expire at the same time. Quadruple witching days replaced triple witching days when single stock futures started trading in November 2002. Because these contracts expire on the same triple witching schedule, the terms triple and quadruple witching are often used interchangeably even however there's a disparity in the number of expiring markets.

All witching dates derive their names from the volatility (or ruin) that results from these products expiring on the same day. When investors move on their positions, it can trigger critical volume and order flow. In folklore, supernatural beings are said to roam the earth during the witching hour of 12 PM with the end goal that being abroad as of now carries ruin and misfortune to those unfortunate enough to encounter these evil spirits.

On double witching dates, two out of the four markets expire simultaneously.

Types of Contracts Involved in Quadruple Witching

Since it has become so obvious what's really going on with quadruple witching, let's take a gander at the four classes of contracts that expire on these dates.

Options Contracts

Options are derivatives, and that means they base their value on underlying securities like stocks. Options contracts give a buyer the opportunity, yet not the responsibility, to complete a transaction of the underlying security at the very latest a specific date and at a preset cost called a strike price.

There are two types of options:

• A call option can be purchased to speculate on a price increase in a specific stock. In the event that the price is higher than the strike price at the option's expiration date, the investor can exercise or convert to shares of the stock and cash out for a profit.
• A put option allows an investor to profit from a decrease in a stock's price the length of the price is below the strike on expiration.

Options expire on the third Friday of every month. There is an upfront fee or premium to buy or sell an option.

Index Options

A index option is just like a stock options contract, yet instead of buying individual securities, index options give investors the right yet not the obligation to execute the index, for example, the S&P 500. Whether the index price or value is above or below the option's strike price on the expiration date determines the profit on the trade.

Index options offer no ownership of the individual stocks. Instead, the transaction is cash-settled. This gives the difference between the option's strike and the index value at expiry.

Single Stock Futures

Futures contracts are legal agreements to buy or sell an asset at a determined price at a specified future date. Futures contracts are standardized with fixed quantities and expiration dates. Futures trade on a futures exchange. The buyer of a futures contract is obligated to buy the underlying asset at expiry while the seller is obligated to sell at expiry.

Single stock futures are obligations to take delivery of shares of the underlying stock at the contract's expiration date. Each contract represents 100 shares of stock. However, holders of stock futures don't receive dividend payments, which are cash payments to shareholders from an organization's earnings.

Index Futures

Index futures are like stock futures except investors buy or sell a financial or stock index with the contract settling on a future date. The existing position is offset when the contract expires, and a profit or loss is cash-settled into the investor's account.

Investors use index futures to bet on the direction of an index, buying assuming they believe the index will rise and selling in the event that they believe the market will drop. Index futures can likewise be used to hedge a portfolio of stocks with the goal that a portfolio manager does not have to sell the portfolio during market declines.

The futures contract earns a profit while the portfolio declines and takes a loss. The goal is to minimize short-term portfolio losses for long-term holdings.

Market Impact of Quadruple Witching

As noted above quadruple witching days witness heavy trading volume. One of the primary reasons for the increased activity is the options and futures contracts that are profitable settle automatically with offsetting trades.

Call options expire in-the-money and are profitable when the price of the underlying security is higher than the strike price in the contract. Put options are in-the-money when the stock or index is priced below the strike price. In the two circumstances, the expiration of in-the-money options results in automatic transactions between the buyers and sellers of the contracts. As a result, quadruple witching dates lead to an increased amount of these transactions being completed.

Market indices, for example, the S&P 500 tend to decline soon after quadruple witching. This might be due to the exhaustion of the near-term demand for stocks. Despite the overall increase in trading volume, quadruple witching days don't necessarily translate into heavy volatility.

Volatility measures the extent of price vacillations in securities. Low volatility could be due to long-term institutional investors, for example, pension funds managers who are largely unaffected since they don't change their long-term positions. The availability of a variety of hedging instruments with multiple expiration dates all through the year has likewise diminished the impact of quadruple witching days to some degree.

While quadruple witching takes place four times per year, stock options contracts and index options expire more frequently — on the third Friday of every month.

Closing and Rolling Out Futures Contracts

A significant part of the action surrounding futures and options on quadruple witching days is focused on offsetting, closing, or rolling out positions. A futures contract contains an agreement between the buyer and seller where the underlying security is to be delivered to the buyer at the contract price at expiration.

For example, one E-mini S&P 500 futures contract is worth 50 times the value of the S&P 500. So the value of an E-mini contract when the S&P 500 is 2,100 at expiration is $105,000. This amount is delivered to the contract owner assuming it is left open at expiration.

Contract owners don't have to take delivery on the expiration date. Instead, they can close their contracts by booking an offsetting trade at the prevailing price with cash settling the gain or loss from the purchase and sale prices. Traders can likewise roll their contracts forward, a process that extends the contract by offsetting the existing trade and simultaneously booking a new option or futures contract to be settled from now on.

The Chicago Mercantile Exchange delisted standard-sized S&P 500 index and options futures contracts in September 2021.

Arbitrage Opportunities

Over the course of a quadruple witching day, transactions including large blocks of contracts can create price movements that might provide arbitrageurs the opportunity to profit on temporary price bends. Arbitrage can quickly escalate volume, especially when high-volume round trips are repeated multiple times over the course of trading on quadruple witching days. However, just as activity can provide the potential for gains, it can likewise lead to losses very rapidly.

There tends to be a great deal of frenzy in the days leading up to a quadruple witching day. However, it's unclear whether the genuine witching leads to increased market gains. That is because it's impossible to separate any gains due to expiring options and futures from gains due to other factors like earnings and economic events.

Friday, March 15, 2019, was the main quadruple witching day of 2019. Similarly as with whatever other witching day, there was hectic activity in the preceding week. As per a Reuters report, trading volume on U.S. market exchanges on that day was "10.8 billion shares, compared to the 7.5 billion average… over the last 20 trading days."

For the week leading into quadruple witching Friday, the S&P 500 was up 2.9% while the Nasdaq was up 3.8%, and the Dow Jones Industrial Average (DJIA) was up 1.6%. However, a large number of the gains that happened really seemed to happen before the quadruple witching Friday since the S&P was exclusively up by 0.5% while the Dow was exclusively up 0.54% Friday.

Features

• Quadruple witching refers to a date on which derivatives of stock index futures, stock index options, stock options, and single stock futures expire simultaneously.
• Quadruple witching does not necessarily translate to increased volatility in the markets.
• Investors might take advantage of the increased volume and arbitrage opportunities that result from quadruple witching.
• This event happens once every quarter, on the third Friday of March, June, September, and December.
• Quadruple witching days witness heavy trading volume mostly because of the offsetting of existing futures and options contracts that are profitable.

FAQ

When Does Quadruple Witching Occur?

Quadruple witching generally happens on the third Friday of March, June, September, and December during the last hour of the trading day.

For what reason Do Traders Care About Quadruple Witching?

Because several derivatives expire at the same moment, traders often seek to close out every one of their open positions in advance of expiration. This can lead to increased trading volume and intraday volatility. Traders with large short gamma positions are especially exposed to price movements leading up to expiration. Arbitrageurs try to take advantage of such abnormal price action, however doing so can likewise be quite risky.

What Are Some Price Abnormalities Observed on Quadruple Witching?

Because traders try to close or roll over their positions, trading volume is as a rule above average on quadruple witching, which can lead to greater volatility. In any case, one interesting phenomenon is that the price of a security may falsely tend toward a strike price with large open interest as gamma hedging takes place, a process called pinning the strike. Pinning a strike imposes pin risk for options traders, where they become uncertain whether or not they ought to exercise their long options that have expired at the money, or are very close to being at the money. This happens because they are additionally unsure of the number of their comparable short positions they will be assigned on at the same time.

What Is Witching and Why Is It Quadruple?

In folklore, the witching hour is a supernatural time of day when evil things might be brewing. In derivatives trading, this term has been casually applied to the hour of contract expiration, often on a Friday at the close of trading. On quadruple witching, four different types of contracts expire simultaneously — listed index options, single-stock options, index futures, and stock futures.