The short version:
- A quadruple witching day occurs when four different types of futures and options contracts expire at once.
- During these days, the market sees a major bump in trading volumes as investors take their positions.
- Despite the large volume of trades, any major spike is usually temporary, because of the work of arbitrageurs who bet on the market's natural fluctuations.
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What is quadruple witching day?
A quadruple witching day is an event that occurs once every quarter in which four different types of futures and options contracts happen to expire at the same time.
These contracts include:
- Single stock futures (mainly the largest market cap stocks)
- Single stock options
- Stock index futures (such as the S&P 500 or Nasdaq)
- Stock index options
This amounts to hundreds of billions of dollars left to hang in the balance. These derivatives each have their own expiry dates — which generally don’t overlap, apart from quadruple witching days.
Because of the abnormally large amounts of expirations occurring at once, what usually follows is a big bump in market volumes as traders scramble to close out or roll out positions.
At the end of a trading day, a trader may either be sitting on a profit — in which case they may want to sell. Or they’ll want to maintain the same position beyond the expiry and choose to sell their current position while also simultaneously buying the next contract available.
More: Swaps and other derivatives: valuable tools or instruments of the devil?
What are the quadruple witching days for 2022?
Quadruple witching days usually occur the third Friday of March, June, September and December. These are the quadruple witching day dates for 2022:
- Friday, March 18th
- Friday, June 17th
- Friday, September 16th
- Friday, December 16th
To look for witching days in 2023 and beyond, you can compare the expiration calendars of stock futures, stock options, stock index futures, and stock index options.
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What happens on quadruple witching day?
Because of the sudden uptick in trades, spread across four major derivatives at once, the trading can often have an impact on the underlying stock indexes or even individual stock names.
Particularly astute investors who can spot a quadruple witching day approaching will generally look for high volume moves in derivatives and their underlying indexes, and try to arbitrage anything that seems to stray from its fair market value.
You can thank these arbitrageurs for keeping the market stable: They're are a big reason why the heavy volume on a quadruple witching day doesn't lead to highly volatile prices where prices pump and dump. In fact, they will generally step in on anything that seems to be irrationally priced and bet on mean reversion (the assumption that the asset price will adjust back to normal price).
All of this adds up to a huge spike in trading volume throughout the day, that usually reaches its zenith of excitement in the final hour of trading — the witching hour. At this hour, anyone stuck with a contract then becomes desperate to deal with it or risk facing an expiry of a contract that they want to offload.
What are contract expirations & why do they matter?
To give some brief background, let’s get into exactly what these expirations mean and why they are so important to how markets function.
First: expiry dates. Just like with many contracts, opens and futures derivatives have an end date, which is publicly known to both buyer and seller. At expiry, the buyer of the contract receives the underlying in exchange for the price they paid.
The futures market (which preceded the options market by decades), was originally conceived as a way for farmers to lock in a price for their goods before they had been harvested and protect against price risks.
Using the example of single stock futures, this means that at expiry, the buyer receives the underlying stock from the seller at whatever price they paid for the futures contract. The profit/loss is the difference between what the underlying is trading at expiry versus what the buyer paid for when they bought the contract.
Once a contract expires and the underlying asset is delivered to the buyer, those profits or losses become locked in. So if a trader is looking at taking a significant loss upon expiry, they may choose to roll the contract to the next month in hopes of a price reversal before the next expiration date.
More: Options vs. stocks
What actually happens on quadruple witching day?
On the day of expiry, traders have two options — allow the contract to expire or ‘roll it over’ to the next contract date. Rolling over means selling their current contract while simultaneously purchasing the next. In this way, traders can get around the expiry issue and indefinitely keep holding their contracts. It's important to note that this may eat into their profit margin if there is a significant gap in the two contract prices on closing date.
Finally, another important part of the derivatives markets is that the vast majority of those who sell these derivative contracts — be it options or futures — are market makers whose job is to provide liquidity in the market. They make most of their money from the volume of trading they do, rather than price speculation.
To this end, these market makers always ‘hedge’ their positions by purchasing or selling an equivalent amount of the underlying asset, to essentially net out any of their risk. As a crude example, a market maker who is selling an option on Apple, will then go ahead and buy 100 regular shares of Apple to ensure that they have no risk of the option trade going against them.
More: What makes stocks go up and down?
Why would “in the money” traders roll over their contracts?
Some may wonder why would a trader ever roll over their contract indefinitely rather than try to take profits. The answer lies in the different participants in these derivatives markets and why they use options or futures in the first place.
While we generally think of traders buying and selling these contracts hoping to bet on the right direction in price alongside high leverage, the fact of the matter is that these speculators are just one piece of the market. On the other end of this trade would be traders and speculators looking to make money on price differences.
These days, many people roll over their contracts continually because they aren’t looking to speculate on prices but are looking to hedge their exposure. Think of a large capital allocator such as a pension fund that has higher than normal exposure to the stock market or a particularly volatile business. Using futures or options, they would be able to manage their exposure and volatility in the short- to mid term, while still enjoying their perceived long term capital appreciation.
More: What can I do to protect my investments from a market downturn?
Why is quadruple witching day important to investors?
For anyone just casually glancing at their stock charts from their computer at home, quadruple witching day might cause a fright as the market may appear more jumpy than usual. Understanding the context of these moves can reduce your anxiety.
It's also important to note that markets tend to decline in the week following a quadruple witching day, with a probability of about 70%. This is again important to know ahead of time. You wouldn't want to panic sell due to what will most likely be a temporary decline.
What does quadruple witching day mean for the rest of us?
Honestly? Most of the time, not much.
As we mentioned before, it’s useful just to keep an eye on the market and not get too spooked if you notice an unusual bump in trading volume or a decline over the week following. Remember: These days, a large number of arbitrageurs are betting on the mean reversion.
But if a major news event does happen to collide with quadruple witching day, that might cause a bigger frenzy in the marketplace that leads to an extended decline. And that, in turn, could make it a good time to consider buying.
More on trading:
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