What Are Triple Witching Days?
Triple Witching Days aren’t about Halloween, but their high trading volumes and volatility still make the stock market jumpy. So, what are Triple Witching Days, and why do they have such an effect on the stock market?
What Is Triple Witching?
Triple Witching occurs four times a year: on the third Friday of March, June, September, and December. The simultaneous expiration of stock options, stock index options, and stock index futures generates large trading volumes and sharp price movements as traders close or renew positions. To add to the fun, the monthly options and index futures contracts expire on this day as well.
Stock Options
Stock options are regular daily, weekly, monthly, and quarterly options tied to individual stocks or exchange-traded funds (ETFs). Each contract represents 100 shares of the underlying security. They give you the right, but not the obligation, to buy or sell a stock at a predetermined price before the option expires. All these options will expire on a Triple Witching Day. Stock options can be settled in stock or cash.
Index Options
Stock index options have weekly, monthly, and quarterly durations. Weekly index options are not sold on weeks ending on a Triple Witching Day. Index options function much like stock options but are derived from popular stock indices instead. They focus on the direction of the index rather than a set price. Index options are only settled in cash since delivering shares of every stock in an index would be impossible.
Index Futures
Stock index futures are futures contracts based on major market indices like the S&P 500 or Nasdaq. Traders often use them for hedging and speculative purposes. Other popular index futures include the E-mini S&P 500, E-mini Nasdaq 100, and E-mini Dow. Note that futures differ from options. Futures are legally binding contracts that must be honored while exercising options is… optional.
The Witching Hour
While a Triple Witching Day is inherently volatile, the last hour of trading is especially so. Known as the Triple Witching Hour, these last sixty minutes often see a surge of activity as traders close or roll over their positions and equity funds rebalance at the last minute. This is also a busy time for arbitrageurs, as increased trading volumes can cause a disconnect with price liquidity.
Puts And Calls
There are two types of options contracts: put and calls.
Put options represent the right to sell a stock at a specific price on or before the expiration date. Much like shorting a stock, puts are bets that the stock (or index) will go down. Call options represent the right to buy a stock at a specific price on or before the expiration date. In either case, the investor does not have to buy or short the actual stock
The advantages that options have over directly shorting or going long on a stock are twofold: you don’t have to exercise the contract if the price moves against you, and options provide a higher degree of leverage. If you decide not to exercise an option, you are only out the amount you paid for the option. In contrast, a short position on a stock can open you up to unlimited losses. While options put a floor on your losses, they also cap your profits.
Index Futures
Stock index futures were originally intended as a hedging instrument for institutional investors, but they are now also available to retail investors and speculators. Since they are derivatives based on an index, index futures are always settled in cash.
Shorts and longs of index futures are legal obligations, not options. Unless the short or long is closed before expiration by purchasing an offsetting position, you must settle the contract at the agreed-upon price.
Index Rebalancing
Some large stock indices use the excessive trading volume of Triple Witching Days to conduct their quarterly or annual rebalancing. Since index rebalances alone can spike trading volumes and volatility as index funds buy an sell stocks to match an index’s new weighting, the additional liquidity of a Triple Witching Day minimizes price mismatches.
The S&P FTSE Global indices rebalance each quarter on the Triple Witching Day, while the Nasdaq does its annual rebalance on December’s Triple Witching Day. These rebalances occur near the close of trading, contributing to the rush of activity during the Triple Witching Hour.
Turbulence Presents Opportunities
The extreme volumes and price movements on Triple Witching Days provide a fertile hunting ground for the prepared investor ready to capitalize on temporary price discrepancies or establish positions to capitalize on trends ahead of the day itself. While the potential profits may be enticing, Triple Witching Days can be a trap for beginning investors. Before swinging for the fences, new traders can learn the basics from the Verified Investing Apprentice Trading Library, then choosing specialty courses to hone their skills.
