What Is Quadruple Witching?
The term quadruple witching refers to the simultaneous expiration four times a year of stock options, index futures, and index futures options derivatives contracts. The fourth type of contract involved in quadruple witching, single-stock futures, hasn't traded in the U.S. since 2020 and was never a major contributor to equity trading volumes. What is now effectively "triple witching" occurs on the third Friday of March, June, September, and December. Equity trading volume tends to rise on these days and is typically heaviest during the last hour of trading as traders adjust their portfolios.
Key Takeaways
- Quadruple witching refers to the simultaneous expiration of stock index futures, stock index options, stock options, and single stock futures derivatives contracts four times a year.
- Quadruple witching has given way to triple witching since single stock futures stopped trading in the U.S. in 2020.
- This event occurs once every quarter, on the third Friday of March, June, September, and December.
- Trading volume typically surges on triple witching days as traders adjust portfolios and roll some contracts.
- Triple witching does not usually cause increased market volatility.
:max_bytes(150000):strip_icc()/Term-Definitions_Quadruple-Witching-Final-V2-2bc13c3671044425bc230da75da2254e.jpg "Quadruple (Quad) Witching: Definition and How It Impacts Stocks (1)")
Understanding Quadruple Witching
The four derivatives contracts accounting for the 'quadruple' in quadruple witching are stock index futures, stock index options, stock options, and single stock futures. While single stock futures now only trade outside the U.S., the quarterly expiration of index futures and index options, coinciding with the monthly stock options expiration, produces a flurry of trading.
Despite the evocative name, what happens during what is now triple witching is not a supernatural phenomenon, nor a mystery. Market makers who've sold expiring stock and index options contracts close out the matched hedge positions, boosting trading volume. Meanwhile, the rolling of contracts ahead of expiration also increases turnover in the options and futures markets.
An additional factor is quarterly index rebalancing, also known as reconstitution, taking place on the "witching" day. That means portfolio managers tracking rebalancing indexes including those from S&P Dow Jones in the U.S. and FTSE in the U.K. may need to make trades reflective of index changes.
Types of Contracts Involved in Quadruple Witching
Now that you know what quadruple witchings are all about, let's take a look at the four classes of contracts that can expire on these dates.
Stock Options
Options are derivatives, which means they derive their value from underlying securities such as stocks. Options contracts give a buyer the right, but not the obligation, to trade a set number of shares of the underlying security at a specified strike price at any time before options expiration.
There are two types of options:
- A call option may be purchased to speculate on a price increase in a particular stock. If the share price is higher than the strike price on the option's expiration date, the investor can exercise the option to buy 100 shares of the stock at the strike price and resell them at the higher market price, or may simply sell the option at a profit before expiration.
- A put option lets an investor profit from a decline in a stock's share price, as long as the price is below the strike at expiration.
Monthly stock options contracts expire on the third Friday of every month. Option buyers pay an upfront cost known as the option premium.
Index Options
An index option works much like a stock options contract, but derives its value from that of an equity index rather than a single stock's share price. The value of the underlying index relative to the option contract's strike price is what determines an index option trade's profitability. As with stock options, index options don't confer an ownership interest.
In contrast with stock options, index options are cash-settled. Another important distinction is that index options are European-style, meaning they can only be exercised on expiration date, while stock options may be exercised at any time before expiration.
Index Futures
Futures contracts are legal agreements to buy or sell an asset at a determined price at a specified future date. Futures contracts are standardized with fixed quantitiesand expiration dates. Futures trade on afutures exchange. The buyer of a futures contract is obligated to buy the underlying asset at expiry while the seller is obligated to sell at expiry.
Index futures cash settle at expiration at the specified price, with the value of the index at the time determining the trade's profitability. Like index options, index futures can be used to hedge a portfolio of stocks, limiting the damage from bear markets.
In a bear market, a trade selling a futures contract earns a profit, offsetting the stock portfolio's loss. The goal is to minimize short-term losses for long-term holdings.
Single Stock Futures
Single stock futures are obligations to take delivery of shares of the underlying stock at the contract's expiration date at a specified price. Each contract represents 100 shares of stock. Holders of stock futures don't receive dividend payments. Even when single-stock futures traded in the U.S. they were a minor market segment relative to the trading flows in stock options and index options and futures.
Market Impact of Quadruple Witching
One reason the combination of monthly and quarterly derivatives expirations generates heavy trading volume is that in-the-money options contracts are subject to automatic exercise, requiring the delivery of the underlying shares in the case of call options.
Call options are profitable when the price of the underlying security is higher than the option's strike price. Put options are in-the-money when the stock is priced below the strike price. In either case, the expiration of in-the-money options results in increased trading volume as the underlying shares are bought or sold to close out the options trade.
Despite the overall increase in trading volume, quadruple witching days do not necessarily add to market volatility.
While quadruple witching takes place four times a year, stock options contracts expire more frequently—on the third Friday of every month.
Closing and Rolling out Futures Contracts
Much of the action surrounding futures and options on quadruple witching days is focused on offsetting, closing, or rolling out positions. A futures contract contains an agreement between the buyer and seller in which the underlying security is to be delivered to the buyer at the contract price at expiration.
For example, one futures contract is worth 50 times the value of the S&P 500. So the value of an E-mini contract when the S&P 500 is 2,100 at expiration is $105,000. This amount is delivered to the contract owner if it is left open at expiration.
Contract owners don't have to take delivery on the expiration date. Instead, they can close their contracts by booking an offsetting trade at the prevailing price by cash settling the gain or loss from the purchase and sale prices. Traders can also roll their contracts forward, a process that extends the contract by offsetting the existing trade and simultaneously booking a new option or futures contract to be settled in the future.
The Chicago Mercantile Exchange delisted standard-sized S&P 500 index and options futures contracts in September 2021.
Arbitrage Opportunities
Over the course of a quadruple witching day, transactions involving large blocks of contracts can create price movements that may provide arbitrageurs the opportunity to profit on temporary price distortions. Arbitrage can rapidly escalate volume, particularly when high-volume round trips are repeated multiple times over the course of trading on quadruple witching days. However, just as activity can provide the potential for gains, it can also lead to losses very quickly.
Pros
Gives arbitrageurs the opportunity to profit on temporary price distortions
Increased trading activity and volume can lead to market gains
Cons
Market gains tend to be fairly modest
The potential for losses can be equally as evident as the potential for gains
Real-World Example of Quadruple Witching
There tends to be a lot of frenzy in the days leading up to a quadruple witching day. But it's unclear whether the actual witching leads to increased market gains. That's because it's impossible to separate any gains due to expiring options and futures from gains due to other factors such as earnings and economic events.
Friday, March 15, 2019, was the first quadruple witching day of 2019. As with any other witching day, there was hectic activity in the preceding week. According to a Reuters report, trading volume on U.S. market exchanges on that day was "10.8 billion shares, compared to the 7.5 billion average… over the last 20 trading days."
Frequently Asked Questions
What Is Witching and Why Is It Quadruple?
In folklore, the late-night "witching hour" was a time of supernatural and occult doings. The appropriation of "witching" to denote the simultaneous expiration of stock and index options and futures contracts was meant to suggest the possibility of surprising market moves driven by the increased trading volumes associated with such quarterly events. In practice, single-stock futures had minimal market impact given the prevalence of stock options. Since single-stock futures no longer trade in the U.S., the quarterly derivatives expiration date is now often called "triple witching."
When Does Quadruple Witching Occur?
Stop options contracts expire monthly, while index futures and options typically settle on the third Friday of March, June, September, and December.
Why Do Traders Care About Quadruple Witching?
When several categories of derivatives expire on the same date, trading volumes tend to rise as in the money options are exercised while market makers square offsetting hedges.
What Are Some Price Abnormalities Observed on Quadruple Witching?
One interesting quirk is that the price of a security may artificially tend toward a strike price with large open interest as gamma hedging takes place, a process known as pinning the strike. Pinning a strike imposespin riskfor options traders, where they become uncertain whether or not options with strike prices near the market price will finish in the money and be exercised.
