Triple Witching: It’s Not as Spooky as it Sounds
A s an investor in the stock market, you need to be aware of certain special trading days throughout the year. On these days, the market may see sudden changes, like an increase in buying or selling. Let’s dive into what exactly triple witching is and why it matters to investors.
What Is Triple Witching?
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Triple witching is when stock options, stock index futures, and stock index options contracts all simultaneously expire or rollover. Futures and options contracts differ from stocks in that they have a set expiration date. Since all of these options expire on the same day, the stock market may experience an increased trading volume and atypical price action on the underlying assets.
Triple witching happens four times a year: on the third Friday of March, June, September, and December. These days are referred to as “Triple Witching Day,” which is when futures investors must decide whether to close their futures position, rollover their futures contracts, or find a position in a non-expired contract. If they choose to close their futures position, this could entail buying or selling, which primarily depends on the direction their original trade went. On a triple witching day, options traders also find out if their contracts end up being in or out of the money.
What Effects Does Triple Witching Have on the Market?
Since the expiration date forces traders to make a decision, the trading volume in certain markets rises. This is especially evident during the triple witching hour, which is the final hour of trading before the market closes for the day. In addition, many traders believe triple witching causes volatility in the underlying markets and expiring contracts. Although this can be true, you may also see lower volatility around and on Triple Witching Day.
Due to the increased trading volume, there may also be some atypical price changes. Likewise, a statistical bias may make it challenging to use your typical day trading strategies.
Things to Know on Triple Witching Day
Although unusual things may happen on a Triple Witching Day, you can make smarter investments by erring on the side of caution.
The way you trade on these days depends on your level of experience, trading strategies, and style of trading. In fact, day traders are known to trade with caution or avoid trading at all on triple or quadruple witching days. Investors and swing traders tend to see less of an impact on triple witching days, although it is useful for them to consider any statistical biases that happen during a triple witching week.
Important Triple Witching Terms
Get to know these terms to have a better understanding of options and futures contracts:
- In the money: This is when an option has intrinsic value. When a call option is in the money, this means that the option holder can purchase the security for less than its current market price. When a put option is in the money, the holder of an option can sell the security for more than its current market price.
- Out of the money: This is when an option has no intrinsic value but has extrinsic value. A call option is out of the money if its underlying price is lower than its strike price. A put option is out of the money when the underlying price is higher than the strike price.
- At the money: This is when the strike price of an option is the same as the price of an underlying security.
- Dividend payments: These are cash payments shareholders receive from a company’s earnings.
Types of Contracts Involved in Triple Witching
In order to fully understand how triple witching impacts the markets, let’s get to know what kind of contracts are involved in triple witching.
Options contracts give you the right, but not the obligation, to buy or sell an underlying security at a set price on or before a predetermined expiration date. Options are a type of derivative since their value is based on underlying securities, like stocks. They expire on the third Friday of every month and require a fee or premium to have the right to buy or sell an option.
Whether you choose to buy or sell depends on the direction of the stock. When investors expect a stock’s price to increase, they may purchase a call option. If they are right and the price is higher than their initial strike price, they can make a profit. If an investor expects the price of a stock to fall, they may invest in a put option. Then, they can sell their asset at a higher price than it’s worth.
Index options are very similar to options contracts in that you do not have the obligation to exercise this right, but they give investors the right to buy or sell an index, like the S&P 500. The index’s price or value is what determines the kind of profit you can make on a trade. Rather than giving you ownership of an individual stock, index options have transactions that are cash-settled. This means that they give the difference between the option’s strike price, the set price at which you can buy or sell an option, and the index value at the expiration date.
Futures are a legal agreement to buy or sell a commodity asset or security at a set price on a predetermined date. When purchasing a future, you are obligated to buy the underlying asset at the expiration date. Likewise, sellers must sell on the expiration date. There are fixed quantities and expiration dates that help standardize futures contracts, and these trades happen through a futures exchange.
Specifically, index futures are a type of futures contract where you can buy or sell a financial index now and have it settled on a future date. A financial index follows the price of an asset or group of assets, meaning they are derivatives of an underlying asset. Portfolio managers use index futures to protect their equity positions from stock losses. You can also use them to bet on the direction of the market.
Other Types of Witching
Along with triple witching, there are important trading days to be aware of:
Double witching happens when any two of the four different classes of stock options, index options, stock index futures, or single stock futures simultaneously expire on the same day. Double witching tends to happen on the third Friday of the other eight months of the year (this would exclude March, June, September, and December). Most often, the contracts that expire on double witching days are options on stocks and stock indices. That’s because futures options often expire on different days.
The term quadruple witching is often used interchangeably with triple witching. It’s when stock options, stock index futures, index options, and single stock futures all expire at once. Like triple witching, quadruple witching day happens four times a year, on the third Friday of March, June, September, and December. And quadruple witching hour is the last hour of trading on these days before the closing bell. On quadruple witching days, you are likely to see a rise in trading volume and arbitrage opportunities.
Quadruple witching originated in 2002 because the expiration of single stock futures was added to the day. With single stock futures, on the expiration date, investors must take delivery of shares or the underlying stock. A futures contract represents 100 shares of a stock, although stock futures holders do not receive dividend payments.
The first quadruple witching of 2019 was on Friday, March 15. During the week prior to this Friday, the market experienced an influx of activity. The trading volume on this day in the United States was up to 10.8 billion shares, while the average was 7.5 billion shares over the prior 20 trading days. Even due to this increase in trading, there is no certainty as to whether witching days lead to market gains. That’s because it’s difficult to determine if such gains are from options and futures expiring or other economic events.
Triple witching doesn’t include all of the expiration dates of stock index futures and options contracts. Keep in mind that day traders tend to avoid trading or change their strategies when triple witching days roll around. When developing your own plan of action, remember that triple witching days tend to experience more drastic market changes, especially in the final hour of trading for the day.