7 Reasons Not to Fear a Quadruple Witching

Answers to common questions about this special expiration day

   

Options expiration is upon us, but it’s not just any old expiration day, it’s a quadruple witching.

Now those words might be enough to strike fear in the feint of heart, but that fear is really just a lack of understanding. A quadruple witching expiration is nothing to be afraid of. And to prove it, I’ll answer some common questions about this witch of a day.

1. What is a Quadruple Witching?

A quadruple witching occurs on the third Friday of March, June, September and December. It is the simultaneous expiration of stock options, index options, index futures and single stock futures. (A triple witching is the expiration of stock options, index options and index futures.) In actuality, the expiration is not “simultaneous.” About 15 years ago, the S&P 500 changed its expiration to an opening settlement price, whereas stock options (and ETF options) still expire on the Friday closing bell — well, sort of. See Options Don’t Expire on Fridays.

2. Does Quadruple Witching Cause Extra Volatility?

The short answer is “no.” What it can do, though, is abet volatility already in progress. If short sellers get trapped, they must chase and, thus, on the margins, they can speed up moves already in progress. The more they chase, the more options shorts get caught, forcing them to chase prices even further. On expiration day, there is no premium cushion to fall back on, so they can create their own fear cycle. See 6 Expiration Day Traps to Avoid.

3. But Hasn’t It Caused a Volatility Spike in the Past?

Well, I’m glad you asked. It wasn’t a “quadruple,” but in August 2007, the Fed rolled out of bed with a surprise discount rate cut on the morning of expiration. The indices gapped higher in the pre-market, and anyone with an SPX position would have no opportunity to close, as they faced a simple cash out on the opening settlement price. Not to mention all the regular expiration options that would have the regular session to hedge, but if short, faced a serious bath. So, in this instance, the fact that it was an expiration day seemed to wildly extend the gap up.

4. Should I Just Avoid the Market on Quadruple Witching Days?

This can all seem a little scary, especially when you’re dealing with cash-settle options, as you’re really at the mercy of events beyond your control. But while it’s never a bad idea to take extra precaution around expiration day, by and large, I feel fears of the witching hour are overblown. The previous example is an exception to illustrate what can happen, not what normally does happen.

5. So What Normally Does Happen?

Well, there’s no such thing as “normal,” but more often than not, you see the absolute reverse of the August 2007 example cited. That’s an instance of trapped option shorts, but more frequently, option longs get trapped. They get stuck with an asset about to decay to intrinsic value, or perhaps even become worthless. So they try to offset this by either selling the options for cheap, or trading the underlying instrument up and back against the expiration option(s). Both have the effect of dampening volatility that day, as they add size to the bids and offers.

6. Can You Predict How Expiration Will Play Out?

Obviously, there’s no crystal ball, but you can take an educated guess. Look at the trend in volatility over the past expiration cycle, giving special weight to the last few days of the cycle. If you saw a time of increasing volatility, you can infer that option shorts have gotten slammed. If they’re scrambling heading into a quadruple witching, odds are they will have to scramble on expiration day. Conversely, if volatility got smacked in the last cycle, it’s the longs that are choking on paper about to expire, so you can expect a yawner.

7. What Should You Expect for This Quadruple Witching?

There’s no saying a surprise can’t happen. By definition, it’s a surprise. So, who knows, maybe some news will come out of the blue in the next few days and get us moving. But the burden is clearly on option owners this cycle as volatility by any metric has trickled lower for the entire cycle. So don’t expect anything out of the ordinary.


Article printed from InvestorPlace Media, http://investorplace.com/2012/09/quadruple-witching-options-expiration-day-questions-answered/.

©2014 InvestorPlace Media, LLC

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