A Brief Overview
This article seeks to examine all that quadruple witching entails. This information is likely to be most helpful to those seeking to learn more about the stock markets.
Quadruple Witching: Meaning Explored
As the name might suggest, quadruple witching is relevant to four entities i.e., stock index futures, stock options, stock index options, and single stock futures. In particular, quadruple witching is the term used to refer to the date on which each of the aforementioned vehicles expires at the same time. When looking at the American stock markets, index options and stock options contracts come to a close on the third Friday each month. That being said, all four of the asset classes mentioned above expire in unison in March, June, September and December on the third Friday of these months.
Examining the Workings of Quadruple Witching
Quadruple witching operates in a similar fashion as triple wishing did at the time single stock futures first began trading in November 2002. Owing to the fact that such contracts expire in line with the triple witching schedule, “quadruple witching” and “triple witching” are frequently used synonymously with one another.
The term witching is used with reference to double, triple, and quadruple witching owing to the volatility that reigns supreme within each of these derivative products that expire on the same day.
Forms of Contracts Engaged in Quadruple Witching
Classified as derivatives, options derive their value from underlying securities that include stocks. Options contracts present buyers with the opportunity – but not the obligation to fulfil transactions pertaining to the underlying security. This may be done on or prior to a predetermined date in line with a predetermined price referred to as the strike price.
Call options can be bought and can involve buyers pondering over the rise in the price of a particular stock. Should the price fall above the strike price at the option’s expiration date, the investor has the liberty to exercise or transform their holding of the stock and walk away with a profit.
Put options on the flip side permit investors to benefit from shortfalls in a given stock’s price provided this price falls below the strike on expiration i.e., the third Friday of each month. Those who seek to buy or sell an option must be willing to pay the premium tethered to it.
Although similar to a stock options contract, index options involve investors acquiring the right – but not the responsibility – to transact the index. This lies in contrast to buying individual securities. How the index price or value falls below or above an option’s strike price at the time of the date of expiry impacts the profit garnered on such a trade.
Ownership of the individual stocks considered is not on offer under index options. Cash-settled transactions arise instead and the difference that exists between the option’s strike and the index value at the time of expiration is made clear.
Single Stock Futures
Futures contracts can be understood to be the legal agreements that outline the purchase or sale of an asset keeping in mind an outlined price and a predetermined future date. These contracts are standardized and refer to fixed quantities and dates of expiry. Futures may be traded on a futures exchange. Here, those that buy futures contracts are responsible for buying the underlying asset at the time of expiration whereas those that sell the same are responsible for selling at the time of expiration.
Single stock futures refer to the responsibility to take delivery of shares of underlying stocks at the time of the contract’s date of expiration. Every contract is representative of 100 shares of stock. That being said, those that hold stock futures do not benefit from dividend payments. Dividend payments here refer to the cash payments that companies allocate to shareholders from their earnings.
While these are akin to stock futures, index futures require investors to buy or sell a stock or financial index wherein the contract settles on a date in the future. At the time of expiration, the present position is offset. The investor acquires a profit or loss which is cash-settled into their account.
Index futures are employed by investors who seek to gamble on the direction of an index. They buy if they are under the impression the index will rise and sell if they feel the market will dip. Index futures may also be employed to hedge a portfolio of stocks. This allows portfolio managers to not feel the need to sell the portfolio in instances of market decline.
Rather, the futures contracts are able to accrue a profit while the portfolio dips and incurs a loss. The goal here is to reduce short-term portfolio losses for holdings that are to be held for long time frames.
Assessing the Market Impact of Quadruple Witching
Days on which quadruple witching arise bear witness to large volumes of trade. One of the driving factors behind this excess activity is the fact that profitable options and futures contracts get settled automatically owing to offsetting trades.
The expiration of call options occurs as in-the-money. They can derive profits when the prices of the underlying securities stand above the strike prices featured under their contracts. In-the-money holds true for put options when the stock or index price falls below that of the strike price. In each of these scenarios, the expiration of in-the-money options leads to automatic transactions arising between buyers and sellers of contracts. Owing to this fact, quad witching dates result in a surge in the number of such transactions being completed.
In the week that follows the one of quadruple witching, market indices including the S&P 500 tend to dip, in part due to having exhausted the near-term want for stocks.