Triple Witching

Triple witching refers to the simultaneous expiration of stock options, stock index futures, and stock index options contracts. This event happens four times a year, on the third Friday of March, June, September, and December. These expiration dates are significant due to the substantial increase in trading volume and volatility that they typically cause in the markets.

Understanding Triple Witching

The term “triple witching” comes from the old belief in witches’ power becoming particularly strong at certain times. In financial markets, it marks a moment when the confluence of expiring derivative contracts can wreak havoc, akin to the chaos one might expect from a gathering of witches. The three main types of contracts expiring simultaneously are:

  1. Stock Options: Contracts that give the holder the right, but not the obligation, to buy or sell a particular stock at a set price before the contract expires.
  2. Stock Index Futures: Contracts obligating the buyer to purchase, or the seller to sell, the value of a particular stock index (e.g., the S&P 500) at a future date.
  3. Stock Index Options: Options on entire stock indices that give the right to buy or sell these indices at a predetermined price.

Market Impact

Increased Volatility

As traders and investors adjust their positions to account for expiring contracts, trading volumes spike, leading to increased market volatility. This heightened activity is primarily driven by arbitrageurs and hedgers who need to roll over their positions or exercise their expiring options.

Market Imbalance

The simultaneous expiration can lead to imbalances in buy and sell orders, which can push stock prices up or down unpredictably. Market makers and institutional traders frequently attempt to anticipate these movements, often leading to frenzied trading activity.

Price Swings

Due to the increased trading volume and volatility, price swings can be more pronounced. Some believe these movements are primarily technical, driven by the mass expiration of contracts and the subsequent rebalancing of trader portfolios.

Liquidity Crunches

Liquidity can dry up as many traders focus on rolling over positions rather than opening new ones. This can exacerbate price movements as even small trades can lead to significant price changes in thinly traded stocks.

Trading Strategy Adjustments

Risk Management

Given the heightened volatility, traders often implement tighter stop losses and position sizing rules to manage risk more effectively during triple witching periods.

Arbitrage Opportunities

Some traders seek to exploit the price distortions caused by triple witching. These arbitrageurs will simultaneously buy and sell different contracts, aiming to profit from price discrepancies.

Hedging

Institutional investors frequently enter into hedging strategies, using options and futures to protect existing portfolio positions against large price movements during these periods.

Historical Examples

March 2020 Triple Witching

In March 2020, as the COVID-19 pandemic began spreading globally, financial markets were already experiencing unprecedented volatility. The triple witching event exacerbated price movements, causing significant fluctuations in major indices and stocks. Traders were particularly active, trying to navigate the uncertainty while managing expiring contracts.

September 2008 Triple Witching

The September 2008 triple witching period occurred shortly after Lehman Brothers filed for bankruptcy. This event further fueled the volatility, as panic selling and repositioning led to intense price swings and trading volumes.

Conclusion

Triple witching is a critical event in financial markets, characterized by the simultaneous expiration of multiple derivatives. While it can create challenges due to increased volatility and potential price swings, it also offers opportunities for savvy traders who can navigate the complex landscape. Proper risk management and strategic adjustments are essential to capitalize on these opportunities while protecting against potential downsides.

For more information on this topic, you can visit Investopedia’s Triple Witching page, which provides a comprehensive overview of the concept and its implications.