Triple Witching In Stock Trading.

Triple Witching might sound absurd, like something from a horror movie. Unlike its name, it is a common financial term. Options and derivatives traders are well aware of this phenomenon since it’s the day when three different types of contracts expire.

So what is Triple Witching?

Triple witching refers to the concurrent expiration of three types of contracts: stock index futures, stock index options, and stock options. This occurs on the third Friday of March, June, September, and December.

What Is the Witching Hour?

In folklore, the “witching hour” actually happens in the dead of night, from 3–4 a.m. The time was thought to be when spirits were at their strongest.

The same goes for the U.S. stock market, the last hour of the trading day, before the closing bell, sees the most trading activity, so the witching hour is from 3–4 pm EST.

What Is Witching and Why Is It Triple?

In folklore, witching hour refers to a period when evil things may be taking place. This has colloquially been used to refer to the expiration hour for derivative contracts, typically on Friday. It is triple which refers to the three different types of contracts that expire simultaneously.

What Happens during Triple Witching?

During triple witching, traders often adjust their positions, which can cause increased volatility and higher trading volume. This can create opportunities for profit but also increases the risk of losses.

One of the reasons for this increased volatility is that traders who have taken positions in futures contracts or options will need to close out those positions before expiration. If they don’t, they could be forced to take delivery of the underlying asset (in the case of futures) or exercise the option, which can lead to unexpected market movements.

It happens only once a quarter and can cause wild swings in volatility, as large institutional traders roll over futures contracts to free up cash. Doing so creates a ton of increased volume—sometimes 50% higher than average, especially in the last trading hour of the day. Triple witching can also be a time when institutional investors rebalance their portfolios, which can affect the prices of individual stocks and the broader market. Individual investors needn’t feel spooked. In fact, some might even view this volatility as a profit-making opportunity.

Types of Derivative Contracts Expire on Triple Witching Day

Stock Index Options: Call and put options where the underlying asset is an index such as the S&P 500. Index options give the owner the right to exercise them, not the obligation. The exercise decision depends on the strike price mentioned in the contract and the price of the underlying index.

Stock Index Futures: These are contracts where the underlying asset is an index, and they’re an agreement (not an option) to buy or sell an index at a future date at a specific price.

Options Contracts: These are contracts taken out in the direction of a stock price at a future date. Unlike stocks, they’re not an investment in a company; rather, they’re the right to buy or sell shares of a company later. Calls let you buy stock shares at a set price, known as the strike price, on or before the expiration date. Puts give you the right to sell shares.

Historical Examples Of Triple Witching

As you might imagine, a lot of trading activity happens when options contracts, index options, and index futures contracts expire. The amount of money involved here is huge!

As reported by Reuters, 10.8 billion shares were traded on U.S. market exchanges on March 15, 2019. During Triple Witching in September 2021, approximately $3.4 T worth of equity options expired.

An incredible $3.5 trillion worth of options expired during Triple Witching on Friday, March 18, 2022. Coincidently, The Federal Reserve announced it might raise interest rates in 2023 to combat inflation the same week.

How Does Triple Witching Affect the Stock Market?

Triple witching itself doesn’t move the stock market; it just creates increased volume. Furthermore, expiring options and futures contracts do not necessarily lead to volatility-instead, it is a result of traders’ actions based on temporary price fluctuations of their underlying assets, which can move due to increased volume.

Triple Witching and Arbitrage

While the majority of the trading in closing, opening, and offsetting futures and options contracts during triple witching days is related to squaring of positions, the surge of activity can also generate price inefficiencies, which attract short-term arbitrageurs.

This gives arbitrageurs an opportunity to take advantage, often completing trades within seconds. Arbitrage allows traders to profit from small price imbalances in a security by buying and selling it simultaneously. There is a great deal of risk involved in this practice.

Is Triple Witching Bullish or Bearish?

There are not always “up” days for the markets during triple witchings, and there are not always “down” days. Typically, it does not significantly trend or change the market’s direction; it simply adds temporary liquidity and volume.

As well as index rebalancing, macroeconomic news events, and market movements can cause big stock market moves when taken in tandem with triple witching, as market volumes tend to be higher during and after these events.

The differences of triple witching and quadruple witch (quad-witch)

The main difference between Triple Witching and Quadruple Witching is the number of financial derivatives that expire on the same day. Triple Witching involves the simultaneous expiration of three different types of financial derivatives: stock options, stock index futures, and stock index options. On the other hand, Quadruple Witching includes the expiration of single stock futures in addition to these three types of derivatives.

In 2020, OneChicago, the exchange where single stock futures were traded, shut down. There is no longer a market for single stock futures in the United States, although they trade internationally.

With the demise of single stock futures, there are only three types of derivatives with concurrent expiration dates. There is therefore no more quadruple witching, there is only triple witching.

Bottom Line

The expiration of these derivatives can create increased trading volume and volatility in the market as traders and investors close out or roll over their positions. However, the impact of Triple Witching on the market can vary, and it’s important to note that not all Triple Witching days will necessarily result in significant market movements.

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