Witching Hour

What Is the Witching Hour?

The witching hour is the last hour of trading on the third Friday of each month when options and futures on stocks and stock indexes expire. This period is often characterized by heavy volumes as traders close out options and futures contracts before expiry. Positions are then often re-opened in contracts that expire at a later date.

Understanding Witching Hours

The witching hour is the final hour of trading before the expiration of derivatives contracts. More often traders will use terms such as "triple witching," which refers to the expiration of stock options, index options, and index futures on the same day. This event occurs on the third Friday of March, June, September, and December.

When single stock futures were traded in the U.S. between 2002 and 2020 they expired on the same quarterly schedule, giving rise to the term "quadruple witching." Meanwhile, double witching occurs on the third Friday of the eight months that aren't triple witching. On double witching, the expiring contracts are options on stocks and stock indexes.

The activity that takes place during monthly witching hours can be broken down into two categories: rolling out or closing expiring contracts to avoid the expiration and purchases of the underlying asset. Due to the imbalances that can occur as these trades are being placed, arbitrageurs also seek opportunities resulting from pricing inefficiencies.

Reasons to Offset Positions

The primary reason for escalated activity on witching hour days is contracts that are not closed out may result in the purchase or sale of the underlying security. For example, futures contracts that are not closed require the seller to deliver the specified quantity of the underlying security or commodity to the buyer of the contract.

Options that are in-the-money (ITM) may result in the underlying asset being exercised and assigned to the contract owner. In both cases, if the contract owner or contract writer is not in a position to pay the full value of the security to be delivered, the contract has to be closed out prior to expiration.

Rolling out or rolling forward, on the other hand, is when a position in the expiring contract is closed and replaced with a contract expiring at a later date. The trader closes the expiring position, settling the gain or loss, and then opens a new position at the current market rate in a different contract. This process creates volume in the expiring contract and the contracts the traders are moving into.

Opportunities for Arbitrage

In addition to the increased volume related to the offsetting of contracts during witching hours, the last hour of trading can also result in price inefficiencies and, with it, potential arbitrage opportunities. Due to heavy volume coming in over a short time frame, opportunistic traders seek imbalances in supply and demand.

For example, contracts representing large short positions may be bid higher if traders expect the contracts to be purchased to close positions prior to expiration. Under these circumstances, traders may sell contracts at temporarily high prices and then close them out prior to the end of the witching hour. Alternatively, they might buy the contract to ride the up wave, then sell once the buying frenzy slows down.