Beware of Today’s Quadruple Witching

Today is the quarterly event known as quadruple witching in which 1) S&P 500 futures, 2) options on those futures, 3) options on individual equities and 4) single stock futures all expire.  In the past, these ‘witching’ days have been characterized by above-average trading volume and increased volatility.  But in the current environment, those are relative terms as both have had record levels for the past three weeks. 

Still, expect some wild gyrations, especially as we head into the close today which could carry over into Monday’s opening as positions get squared away, hedges established and positions rebalanced. But don’t worry, it’s not as scary as it sounds. While there will likely be higher than normal trading volume, the “witching” days tend to be less volatile than when the term was first coined some 30 years ago, and back then it was merely a ‘triple’ witch.   

Some of the reasons for the lower volatility include a staggering of expiration periods, a plethora of new products — such as ETFs — and the addition of weekly, monthly and quarterly option expirations, which have diffused the impact of the quarterly contract rollovers.    

First off, we can dismiss Single Stock Futures, which launched in 2002 but never really gained traction.  There are just over 100 issues listed, down from over 400 10 years ago, and open interest is minimal with none having more than 6,000 contracts open.  So, I think it is safe to say this dog has too short a tail to wag.  

That brings us back to the original, and I think the more ominously sounding triple-witching.  But this too, through adjustments to settlement and cessation of trading, has had the starch taken out of its ability to cause unsettling volatility.  It was well over a decade ago that the exchanges shifted the cessation of trading of index products to occur on Thursday and created a settlement based on Friday’s opening.  While it has done much to dampen some of the final hour volatility it comes with its own quirks and complications. Here is what you need to know. 

Taken from the “Chicago Mercantile Exchange (CME)” website, “The Standard & Poor’s 500 Index futures (SP) will cease trading on Thursday and then use a settlement price is the Special Opening Quotation (SOQ) of the S&P 500 Index in the morning of the third Friday of the contract month. The S&P 500 Index SOQ is calculated using the official opening prices of the index’s component stocks on that day.”  To understand the Special Opening Quotation, look here. 

Likewise, trading in SPX options also ceases Thursday and also has its own settlement value calculated similarly. But, given the acronym SET, this process is also in place for a host of other index products such as the “Russell 2000 (IWM)”, the VIX and even Gold Volatility Index (GVZ).  The reason I’ve wasted 100 words on these special settlements is that they can have a very wide price differential from both Thursday’s closing price and the “real” opening price of the index on Friday morning.    

For example, last month’s expiration SET was 285.70 while the official opening print in the S&P was 290.30, a 5-point difference that determines whether an option will be in-the-money or not.  So, in essence, the market opened unchanged but the options were settled on a price 5 points lower.   

This is not an unusual occurrence as there have been numerous times over the years that the SET and SAQ have posted a price nearly 1% deviation from the Thursday close and the “official” Friday opening.  The take-away is if you are trading index options, S&P VIX or others, be very careful not to assume based on Thursday’s close anything will be worthless or of value come Friday.   

An added twist to this was the fact that yesterday was the quarterly ex-dividend for the “SPDR Trust (SPY),” meaning if you want to collect the $1.13 per share, you needed to be an owner of record at yesterday’s close.  Meaning, those that were long in-the-money calls would be exercising their options a day earlier than expiration.  

Many shorted those calls were aware and to avoid being assigned covered or bought shares right at the close.  

Bring in the ETFs, Weeklies, Monthlies, Quarterlies…Oh My 

A bigger factor in the dampening of the witching effect is the explosion of new products and the expansion of expirations offered.  We’re all pretty familiar with the success of the major index products such as the SPY and iShares Russell 2000 (IWM) and some of the sub-sector ETFs.  The volume and open interest on these products, even when adjusted for the 1/10th notional value, is nearly equal to the major index products.   Now, throw in that both the futures and these ETFs have listed options that have weekly, monthly and quarterly expirations and there is a further diffusion of the witching hour.

In fact, many money managers, and more and more individual investors, have realized that it makes sense to start rolling positions on Wednesday prior to expiration to avoid such quirks. And this in itself has helped dampen the Friday effect. Over the past 12 quarters, volume in both stocks and options have only averaged 2.5% higher on witching days than a normal Friday expiration.  And the average price move has been 0.41%. Those numbers will be dwarfed today. But, that’s due to the coronavirus, not the witch. 

.INX shares were trading at $239.02 per share on Friday afternoon, down $0.08 (-0.03%). Year-to-date, .INX has declined -25.74%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Steve Smith

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More…

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