Triple Witching Explained: Definition and Stock Market Impact
Triple witching refers to the concurrent expiration of three types of market derivatives: stock options, stock index futures, and stock index options. This event occurs on a quarterly basis, specifically on the third Friday of March, June, September, and December. The alignment of these expiration dates tends to elevate trading volume and can lead to unusual price movements in the stocks or indexes tied to these contracts.
Key Points
Triple witching signifies the simultaneous end of three different types of derivative contracts.
It happens quarterly, leading to a notable increase in market activity and potential shifts in asset pricing.
Although associated with increased trading volumes, triple witching does not inherently cause significant market volatility.
In-depth Analysis
The concept of triple witching is integral to understanding market dynamics on specific dates. On these days, there is a significant uptick in market activity as traders and investors close, adjust, or roll over their positions to avoid the risks and obligations associated with the expiration of their contracts. Particularly notable is the "triple witching hour"—the last hour of trading before the market close—which often witnesses a surge in volume and volatility as market participants make their final adjustments.
Managing Expiring Contracts
When it comes to futures contracts, they represent agreements to buy or sell an underlying asset at a predetermined price on a specified future date. As the expiration date approaches, holders of these contracts must decide whether to settle the contracts (by completing the purchase or sale of the underlying asset) or to close out their positions to avoid the obligations of the contract. This often involves "rolling out" the contract, which means closing the current position and opening a new one for a future date. The actions surrounding futures and options contracts are especially pronounced on triple witching days, as traders aim to manage their exposure and avoid unwanted outcomes.
Options and Expiration Dynamics
Options contracts offer the right, but not the obligation, to buy (call options) or sell (put options) the underlying asset at a set price by a certain date. As options approach their expiration date, those that are "in the money" (i.e., have value) lead to strategic decisions for the holders. They must decide whether to exercise the options, close them, or let them expire. This can lead to automatic executions and significant movements in the underlying stocks, especially when large numbers of options are involved.
Triple Witching and Market Arbitrage
The heightened trading activity on triple witching days can create temporary pricing inefficiencies, attracting arbitrageurs who seek to profit from these anomalies. These traders engage in high-volume transactions to capitalize on small price discrepancies, often completing these trades in a very short time frame.
Frequently Asked Questions:
What Exactly Is Triple Witching? It's a term from finance that refers to the simultaneous expiration of stock options, stock index futures, and stock index options, leading to increased trading activity.
How Does Triple Witching Affect Stocks? While triple witching can lead to heightened trading volume and price fluctuations, its impact can vary. Individual stocks, particularly those with large open positions in derivatives, may experience more pronounced effects, such as unusual price movements or increased volatility. However, these changes are often temporary and not directly linked to the underlying company's fundamentals.
Related research papers
Our review of the academic papers related to the triple witching week impact on stock market revealed the following findings:
Triple witching, the simultaneous expiration of index futures, index options, and options on index futures, leads to higher market volatility and volume, especially during the last hour of trading on expiration days (Stoll & Whaley, 1987).
Changes in settlement times, such as from the close to the open of trading, altered the price volatility and trading volume patterns during and after triple witching hours (Stoll & Whaley, 1991).
In Sweden, changing the expiration day for OMXS 30 index derivatives showed no significant increase in market volatility or price distortion, despite the introduction of "quadruple witching Fridays" (Xu, 2014).
ETF settlement failures increase during triple witching dates, affecting market index volatility and highlighting the influence of market structure on stability (Stratmann & Welborn, 2012).
Significant increase in trading volume on quarterly futures expiration days has been observed in Germany, indicating market-wide effects of expiration days (Schlag, 1996).
Options expiration effects in the presence of individual stock futures contracts with different settlement methods show that the availability of futures contracts attenuates expiration effects on price volatility and trading volume. Also, stock prices tend to move up near expiration days after physical delivery replaces cash settlement, indicating the impact of gamma and other Greeks near expiration (Lien & Yang, 2003).
A study on the weekly returns over option-expiration (OE) weeks for S&P 100 stocks finds that these weeks tend to have higher returns relative to other weeks. The patterns suggest influences from option-related activities such as delta-hedge rebalancing by option market makers and declining risk perceptions measured by option-derived implied volatilities (Stivers & Sun, 2013).
So far, we've observed a lot of interesting phenomena. As market practitioners, we are not just interested in anomalies themselves but in ways we can exploit them to make money.
As our intuition suggested, periods of high-volume trading impact liquidity. Sharp changes in liquidity typically affect price action. Also, periods when many investors need to take some forced action to manage their trades (e.g., the decision to roll or to exercise options, or maybe take profit from options-based stock replacement strategies) should also generate some tradable anomalies.
Indeed, as our intuition suggested, after carefully studying the performance of different contracts during the quarterly expiration weeks, we were able to spot some interesting patterns that we can try to exploit.
Based on this research, we have developed trading strategies mentioned below, available to TradeMachine's paid members. Our research in this field is still ongoing, and we expect to deliver more OpEx (day/week) related strategies in the near future.
