What is Triple Witching?
Triple witching is the quarterly expiration of stock options, stock index futures and stock index option contracts all occurring on the same day. It happens four times a year - on the third Friday of March, June, September and December.
Understanding Triple Witching
Triple witching days generate trading activity and volatility because contracts that are allowed to expire may necessitate the purchase or sale of the underlying security. While some derivative contracts are opened with the intention of buying or selling the underlying security, traders seeking derivative exposure only must close, roll out or offset their open positions prior to the close of trading on triple witching days.
Triple witching days, particularly the final hour of trading preceding the closing bell which is called the 'triple witching hour', can result in escalated trading activity and volatility as traders close, roll out or offset their expiring positions.
Since 2002, triple witching days have also included the expiration of single stock futures, meaning there are actually four types of expiring contracts, but the term "quadruple witching" has never caught on.
- Triple witching is the quarterly expiration of stock options, stock index futures and stock index option contracts all occurring on the same day.
- Triple witching happens four times a year - on the third Friday of March, June, September and December.
- Triple witching days, particularly the final hour of trading preceding the closing bell which is called the 'triple witching hour', can result in escalated trading activity and volatility as traders close, roll out or offset their expiring positions.
Offsetting Futures Positions
A futures contract, which is an agreement to buy or sell an underlying security at a predetermined price on a specified day, mandates the agreed-upon transaction to take place after the expiration of the contract. For example, one futures contract on the Standard & Poor’s 500 index (S&P 500) is valued at 250 times the value of the index. If the index is priced at $2,000 at expiration, the underlying value of the contract is $500,000, which is the amount the contract owner is obligated to pay if the contract is allowed to expire.
To avoid this obligation, the contract owner closes the contract by selling it prior to expiration. After closing the expiring contract, exposure to the S&P 500 index can be maintained by purchasing a new contract in a forward month. This is referred to as rolling out a contract.
Options that are in the money present a similar situation for holders of expiring contracts. For example, the seller of a covered call option can have the underlying shares called away if the share price closes above the strike price of the expiring option. In this situation, the option seller has the option to close the position prior to expiration to continue holding the shares, or allow the option to expire and have the shares called away.
Triple Witching and Arbitrage
While much of the trading in closing, opening and offsetting futures and options contracts during triple witching days is related to the squaring of positions, the surge of activity can also drive price inefficiencies, which draws short-term arbitrageurs. These opportunities are often the catalysts for heavy volume going into the close on triple witching days, as traders attempt to profit on small price imbalances with large round-trip trades that may be completed in seconds.