Quadruple witching is when stock index futures, stock index options, stock options, and single stock futures all expire on the same day.
While stock options and index options expire on the third Friday of each month, all four asset classes expire on the same day in March, June, September, and December.
Quadruple witching is a date when stock index futures, stock index options, stock options, and single stock futures all expire at the same time.
Every quarter, on the third Friday of March, June, September, and December, quadruple witching takes place.
Due to the offsetting of previous profitable futures and options contracts, quadruple witching days see a lot of trading action.
What Is Quadruple Witching, and How Does It Work?
Quadruple witching may result in more volume and arbitrage opportunities, but it does not always imply increased market volatility.
Quadruple witching dates are comparable to triple witching dates, which occur when three of the four markets expire at the same time, or double witching days, which occur when two of the four markets expire at the same time.
When single stock futures began trading in November 2002, quadruple witching days replaced triple witching days.
The terms “triple witching” and “quadruple witching” are commonly used interchangeably since these contracts expire on the same triple witching schedule (despite the disparity in the number of markets).
The volatility—or havoc—inherent in all of these derivative goods expiring on the same day gives rise to the terms quadruple, triple, and double witching.
According to legend, supernatural creatures walk the earth during the witching hour of midnight, wreaking havoc and bringing bad luck to those unfortunate enough to come into contact with these wicked spirits.
Quadruple witching contracts include a variety of different types of contracts.
The four types of contracts involved in quadruple witching are listed below.
Options Contracts are derivatives, which means their value is based on the value of underlying securities like stocks.
Options contracts provide a buyer the option, but not the obligation, to complete a transaction of the underlying security on or before a certain date and at a predetermined price known as the striking price.
A call option can be acquired to speculate on a stock’s price increasing. If the price of the stock is greater than the strike price on the expiration date of the option, the investor can exercise or convert the option to stock shares and cash out for a profit.
A put option allows an investor to profit from a drop in the price of a stock as long as the price is below the strike price at the time of expiration.
Options expire on the third Friday of each month, and buying or selling an option requires an upfront charge or premium.
Options for Indexing
An index option is similar to a stock option contract, except instead of buying individual stocks, index options allow investors the right to trade an index, such as the S&P 500, rather than the duty to do so.
The profit on the trade is determined by whether the index price or value is above or below the option’s strike price on the expiration date.
Individual stock ownership is not available with index options. Instead, the transaction is completed in cash, with the difference between the strike price of the option and the index value at expiry being paid out.
Futures on a single stock
Futures contracts are legal agreements to acquire or sell an item at a predetermined price on a predetermined date in the future.
3 Futures contracts are standardised, with amounts and expiration dates that are set in stone. A futures exchange is where futures are traded.
A futures contract’s buyer is bound to buy the underlying asset at expiration, while the seller is required to sell.
At the contract’s expiration date, single stock futures are obligations to accept delivery of shares of the underlying stock.
Each contract entails the purchase of 100 shares of stock. Stock futures holders, on the other hand, do not get dividends, which are cash payments made to shareholders from a company’s earnings.
Futures on Indexes
Investors buy or sell a financial or stock index with the contract settling on a future date, comparable to stock futures.
The existing position is offset at expiration, and the investor’s profit or loss is cash-settled into his or her account.
Investors wager on the direction of an index by purchasing index futures if they believe the index will climb and selling if they believe the market will fall.
Index futures can also be used to hedge a stock portfolio, allowing a portfolio manager to avoid selling during market downturns.
The futures contract, on the other hand, makes a profit while the portfolio loses money. The goal is to keep short-term portfolio losses to a minimum for long-term investments.
Quadruple Witching’s Market Impact
Trading volume is high on quadruple witching days. Profitable options and futures contracts settle automatically with offsetting trades, which is one of the main causes for the rising activity.
When the price of the underlying securities is greater than the strike price in the contract, call options expire in the money and are profitable.
When the stock or index is trading below the strike price, put options are in the money. In both cases, the expiration of in-the-money options triggers automated transactions between the contract’s buyers and sellers.
As a result, quadruple witching dates result in a higher number of completed transactions.
Following the quadruple witching week, market indices like the S&P 500 tend to fall, possibly due to a lack of near-term demand for stocks.
Despite the rise in overall trading volume, quadruple witching days may not always imply high volatility.
Volatility is a measure of how much a security’s price fluctuates. Long-term institutional investors, such as pension fund managers, may be mainly unaffected by low volatility because they do not adjust their long-term positions.
The availability of a number of hedging instruments with numerous expiration dates throughout the year has also helped to mitigate the impact of quadruple witching days.
Futures Contracts are being closed and rolled out.
On quadruple witching days, a lot of the action in futures and options is centred on offsetting, closing, or rolling out bets.
A futures contract is a contract between a buyer and a seller in which the underlying security is to be delivered to the buyer at the agreed price when the contract expires.
For example, the price of the index is multiplied by 50.45 to value Standard & Poor’s 500 E-mini contracts, which are 20% of the size of the regular contract.
If a contract with a value of 2,100 is left open upon expiration, the value is $105,000, which is delivered to the contract owner.
Contract owners do not accept delivery on the expiration date, but instead can close their contracts by booking an offsetting trade at the current price, settling the profit or loss from the purchase and selling prices.
Traders can also roll the contracts forward by offsetting an existing deal and simultaneously booking a new option or futures contract to be settled in the future.
Opportunities for Arbitrage
Transactions involving huge blocks of contracts can cause price changes over the length of a quadruple witching day, giving arbitrageurs the opportunity to profit from momentary market distortions.
Arbitrage can quickly increase volume, especially when high-volume round trips are repeated several times during trade on quadruple witching days.
However, just as activity can result in gains, it can also result in significant losses.
Quadruple Witching in the Real World
The first quadruple witching day of 2019 was Friday, March 15, 2019. During that week’s frenzy running up to Friday, market activity spiked.
However, it’s tough to distinguish between gains due to expiring options and futures and gains owing to other variables such as earnings and economic developments, thus it’s unclear whether the witching contributes to larger market gains.
According to Reuters, trade activity on U.S. market exchanges was “10.8 billion shares on March 15, 2019, compared to the 7.5 billion average… during the prior 20 trading days.”
The S&P 500 was up 2.9 percent for the week leading up to quadruple witching Friday, while the Nasdaq was up 3.8 percent and the Dow Jones Industrial Average (DJIA) was up 1.6 percent.
However, majority of the gains appear to have occurred before to Friday’s quadruple witching, as the S&P was only up 0.5 percent and the Dow was only up 0.54 percent.
What Is Quadruple Witching, and Why Is It Called That?
The “witching hour” is a magical time of day when bad things may be afoot, according to legend.
This word has been used in derivatives trading to refer to the hour of contract expiration, which is usually on a Friday at the close of trading.
Four separate types of contracts expire at the same time during quadruple witching: listed index options, single-stock options, index futures, and stock futures.
Quadruple Witching Occurs When?
At market closure on the third Friday of March, June, September, and December, quadruple witching happens (4:00 pm ET).
Why Is Quadruple Witching Important to Traders?
Due to the fact that numerous derivatives expire at the same time, traders will frequently try to close out all of their open positions before the expiration date. Increased trading volume and intraday volatility may result as a result of this.
Traders that have significant short gamma positions are more vulnerable to price changes near expiration.
Arbitrageurs strive to profit from unusual market movements, but they can be highly dangerous.
What Price Abnormalities Have Been Observed During Quadruple Witching?
Because traders are attempting to close or roll over their positions, trading activity on quadruple witching is typically higher than average, resulting in higher volatility.
However, as gamma hedging takes place, the price of a security may artificially drift toward a strike price with substantial open interest, a phenomenon known as pinning the strike.
Options traders face pin risk when a strike is pinned, as they are unsure whether or not to exercise long options that have expired at the money or extremely near to being at the money.
This is because they are unknown how many of their similar short positions they will be assigned to at the same time.