What Is Triple Witching?
Triple witching is the simultaneous expiration of stock options, stock index futures, and stock index options contracts all on the same trading day. This happens four times a year: on the third Friday of March; June; September; and December. Because three options classes that could share the same underlying expire all on the same day, it can cause increased trading volume and unusual price action in the underlying assets.
- Triple witching is the simultaneous expiration of stock options, stock index futures, and stock index options contracts all on the same day.
- Triple witching occurs quarterly—on the third Friday of March, June, September, and December.
- Triple witching days, particularly in the final hour of trading preceding the closing bell—called the "triple witching hour"—can see increased trading activity as traders close, roll out, or offset their expiring positions.
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, known as the "triple witching hour," can result in escalated trading activity and volatility as traders close, roll out, or offset their expiring positions.
Since 2002, with the debut of single stock futures, there have actually been four types of expiring contracts, meaning triple witching days are often in fact a "quadruple witching," though this term has not quite caught on.
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.
Much of the action surrounding futures and options on triple witching days are focused on offsetting, closing, or rolling out positions. For example, Standard & Poor’s 500 E-mini contracts, which are 20% of the size of the regular contract, are valued by multiplying the price of the index by 50.1 2 On a contract priced at 2,100, the value is $105,000, which is delivered to the contract owner if the contract is left open at expiration.
On the expiration date, contract owners do not take delivery and instead, can close their contracts by booking an offsetting trade at the prevailing price cash settling the gain or loss from the purchase and sale prices. Traders can also extend the contract by offsetting the existing trade and simultaneously booking a new option or futures contract to be settled in the future—a process called rolling the contracts forward.
Options that are in the money (ITM) 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.
Call options expire in-the-money and are profitable when the price of the underlying security is higher than the strike price in the contract. Put options are in-the-money when the stock or index is priced below the strike price. In both situations, the expiration of in-the-money options results in automatic transactions between the buyers and sellers of the contracts. As a result, triple witching dates lead to an increased amount of these transactions being completed.
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.
Despite the overall increase in trading volume, triple and quadruple witching days do not necessarily translate into heavy volatility.
Real World Example of Triple Witching
Friday, March 15, 2019, was the first triple witching day of 2019. Trading volume leading up to this third Friday of the month saw increased market activity. According to a Reuters report, trading volume on March 15, 2019, on U.S. market exchanges was "10.8 billion shares, compared to the 7.5 billion average" over the past 20 trading days.
For the week leading into triple witching Friday, the S&P 500 was up 2.9% while the Nasdaq was up 3.8%, and the Dow Jones Industrial Average (DJIA) was up 1.6%. However, it appears much of the gains happened before triple witching Friday since the S&P was only up by 0.5% while the Dow only up 0.54% Friday.
Frequently Asked Questions
What is "witching" and why is it triple?
In folklore, the "witching hour" is a supernatural time of day when evil things may be afoot. In derivatives trading, this has been colloquially applied to the hour of contract expiration, often on a Friday at the close of trading. On triple witching, three different types of contracts expire simultaneously: listed index options, single-stock options, and index futures. On triple witching days, single stock futures also expire.
When does triple witching occur?
Triple witching usually occurs on the third Friday of March, June, September, and December, at market close (4:00 pm EST).
Why do traders care about triple witching?
Because several derivatives expire at the same moment, traders will often seek to close out all of their open positions in advance of expiration. This can lead to increased trading volume and intraday volatility. Traders with large short gamma positions are particularly exposed to price movements leading up to expiration. Arbitrageurs try to take advantage of such abnormal price action, but doing so can also be quite risky.
What are some price abnormalities observed on triple witching?
Because traders will try to close or roll over their positions, trading volume is usually above average on triple witching, which can lead to greater volatility. However, one interesting phenomenon observed is that the price of a security may artificially tend toward a strike price with large open interest as gamma hedging takes place.
This can lead the price to "pin" the strike at expiration due to this sort of trading activity. Pinning a strike imposes pin risk for options traders, where they become uncertain whether or not they should exercise their long options that have expired at the money, or very close to being at the money. This is because, at the same time, they are unsure of how many of their similar short positions they will be assigned on.