Derivative contracts, such as futures and options, derive their value from the price movements an underlying asset. They can be used to speculate or hedge investment bets. Futures and options contracts are agreements to exchange underlying asset at a future date and price. The date outlined in the contract is called the expiry date. Triple witching occurs when three types have expiry dates scheduled for the same day. Typically, this phenomenon occurs on the third Friday of the last month in a quarter. That means the third Friday in of March, June, September, and December. The three types of derivative contracts that expire on triple witching are:
Stock Index Options: Call and put options where the underlying assets is an index such as the S&P 500. Index options give the owner the right, not the obligation to exercise the contract. The exercise decision depends on the strike price mentioned in the contract and the price of the underlying index. Stock Index Futures: Stock index futures contracts where the underlying asset is also an index and they are an agreement (not an option) to buy or sell a stock index at a future date and a specific price. Single Stock Options: Options contracts which give the holder the right to buy or sell the underlying stock of a single company.
On the expiration date, futures and options (if exercised), must be settled which means either the underlying asset needs to be delivered or the settlement is made using cash. Stock index futures and options are typically cash-settled, whereas you need to deliver the stock in case of single stock options. Investors may also choose to rollover their derivative contracts, which means closing out this particular contract that is about to expire and entering into a similar contract that expires at a later date.
Quadruple Witching
With the addition of single stock futures contracts in 2002, which also expired on these days, triple witching was sometimes referred to as quadruple witching or quad witch—because now there were four types of contracts with simultaneous expiry. However, in 2020, OneChicago, the exchange where single stock futures were traded shut down. While single stock futures trade elsewhere internationally, they no longer trade in the United States. With single stock futures ceasing to trade, there are only three types of derivatives with concurrent expiry on four days of the year. Therefore, there is no more quadruple witching, only triple witching.
Triple Witching Impact on the Market
Triple witching is when futures traders will have to decide if they will roll their contracts over and maintain a position in a non-expired contract, or close their futures position, which could be buying or selling, depending on the direction of their original trade. Options traders also find out if their options expire in or out of the money. On such days, traders with large positions in these contracts may be financially incentivized to try to temporarily push the underlying market in a certain direction to affect the value of their contracts. The expiration forces traders to act by a certain day, causing trading volume in affected markets to rise. In some cases, this may be true, but triple witching can also be a rather calm event, with lower volatility and a statistical bias to the upside (at lease for S&P 500 futures) during the week of and on triple witching. Another aspect to consider on how triple witching could indirectly impact markets is to look at index rebalancing. Index providers periodically tweak the constituents and weights accorded to those constituents in the index based on their methodology. Liquidity generated by large trade volume during triple witching makes a good time for indexes to rebalance. Any changes in the indexes leads to portfolio adjustments by index-based securities such as index funds.
What To Watch Out For
Because of the increased volume, the chance of some abnormal price moves—and a statistical bias which may cause some day trading strategies not to work (which work during non-triple witching weeks/days)—some day traders recommend caution, and others recommend not trading at all. How an individual day trader chooses to handle triple witching will depend on their trading style, trading strategies, and level of trading experience. New traders will want to be more cautious in the days leading up to and on Triple Witching Friday. If a day trader opts to trade during these weeks, measures should be taken to ensure the strategy being used works in such an environment, or a new strategy can be constructed specifically for this week. Swing traders and investors are unlikely to be significantly affected by the event, but swing traders may wish to take note of any statistical biases present during the week of triple witching.
The Bottom Line
Triple witching does not include all of the stock index futures and options contracts, so even though they are the most talked-about expiration events, they are not the only expiration days. Short-term traders should adapt their strategies to these conditions, avoid trading, or reduce their position size if they notice their performance deteriorates during this time.
