Triple Witch – It’s Here – But What is It?

This is “Triple Witch” Week. You may hear it mentioned on TV or read it in a publication. The explanation of Triple Witch is pretty simple.

Since listed options arrived, we’ve had Expiration Friday, the third Friday of the month (expiration is actually the Saturday following the third Friday, but we’ve always called it Expiration Friday). All stock (or equity) options settle at the closing price on Friday afternoon. All baskets of stocks (Indexes and ETF’s) used to settle at the closing print Expiration Friday and S&P Futures at The CME used to settle on the closing of stocks that same Friday afternoon – but only every Quarter (March, June, September and December).

So quarterly expiration on those Friday’s had a tendency to get a little crazy. For example, a trader or arbitrageur might need to buy 500,000 shares of IBM on the close to cover a short position. This might push the closing price of IBM higher by $1 or more. But that same trader might have been long S&P Futures, or In-The-Money calls in the SPX or OEX. The trader didn’t care what price they paid for IBM shares, he or she was hedged with Index options or Futures, IBM is a component of those baskets and would reflect the higher price of IBM. 

To eliminate a great deal of this increased volatility, some of the baskets of stock (like SPX options) had their expiration settlement value changed to reflect the opening print on the Friday of expiration. This is called A.M. Settlement. Most Indexes are A.M. Settlement. S&P Futures cease to trade on Thursday afternoon. So a trader wishing to close a stock position Friday afternoon might have part of the offsetting hedge closed out Friday morning with Index options or Thursday afternoon with the futures position.

Many traders have been winding down their June positions, “rolling” their Futures to September and their options positions to July, August or September (rolling in this case involves closing a June position and opening a July or September position). By the way, September is considered the “Front Month” or “Top Step” future, and has been for the last week. So if you’re watching the June S&P 500 Future, start paying attention to September.

A trader with a position of short stock and long call options, or short stock and long futures is not in the business of taking overnight risk, or the risk of a position from the opening to closing on Expiration Friday. By changing some indexes to A.M. Settlement, it reduced the impact of Triple Witch.

One recent development is the term “Quadruple Witch”. S&P Futures have Futures options, so these positions have an impact, albeit small, on trading Friday. I’m an old-timer; I still call it Triple Witch.  

Expiration Friday could cause a slight blip in the market, but not to the extent it used to. Not too many market watchers get concerned with the effect of Triple Witch anymore (one reporter on “Closing Bell” does, but she’s about the only one I know of).  So when you hear the term Triple Witch, it’s the Quarterly expiration of stock options, index options and Futures.

Dr. Kearney’s Option Clinic is now closed.