As scary as it sounds, quadruple witching shouldn’t be something that investors fear. Quite on the contrary, nimble traders may even be able to profit from this options expiry calendar phenomenon.
What Is Quadruple Witching?
These two frightening words refer to the simultaneous expiration of stock options, single stock futures, stock index futures, and stock index options. This takes place four times a year on the third Friday of March, June, September, and December. Since investors must close out of their futures and options positions across all four asset classes named above on the same day, quadruple witching is understandably associated with increased trading volume.
Consider 2016’s options expiry calendar below:
What Are the Effects?
So what happens when four different derivatives reach their final trading day all at the same time? The name of this expiry calendar phenomenon would have you believe that witches cast a spell of doom on Wall Street. Here’s what really happens:
- Investors are prompted to unwind their futures and options contracts on expiration day, which includes repurchasing (rolling) or entirely closing out of their positions across several asset classes.
- The combined effects of many participants across markets all trading at the same time can lead to a noticeable increase in trading volumes that day; by some measures there can be as much as a 50% jump in trading activity on quadruple witching days.
- There is evidence of increased intraday volatility, however, the most consistently observable effect of quadruple witching is an increase in trading volume
When you break it down, it’s clear that what’s happening under the surface of an ill-named trading day is nothing more than a spike in trading activity. While there are instances when the timing of this day does coincide with a particularly volatile trading session on Wall Street, its effects in this regard are weak and inconsistent.
What Does It All Mean for ETF Investors?
The increase in trading volume that is associated with quadruple witching could be a problem for some in certain situations. More specifically, if you are looking to trade on this day, be prepared to deal with widened bid-ask spreads if the above-average trading activity spirals into a volatile frenzy on Wall Street.
For buy-and-hold investors, however, this day is pretty much a nonevent. There’s not much to do on quadruple witching days besides sticking to your rules and reviewing your buy list if you’re a passive investor; because this day historically has not had an outsized impact from a volatility perspective, there simply isn’t much to worry about.
Ways to Play Quadruple Witching With ETFs
Nimble traders, on the other hand, can take advantage of the expected uptick in trading volumes and potential spike in volatility. For starters, there are a number of funds focused around volatility itself:
- See all Volatility ETFs.
Traders should note that (XIV ) has garnered a reputation as the go-to vehicle for betting on volatility; even so, do your homework as this inverse volatility ETF comes with a list of nuances, most notably its expected behavior across different market cycles.
The other way to play this day is to keep your eye on trading setups across the most liquid ETFs in the investable universe. The ETF Cheat Sheet is a great starting place for generating a watch list of funds that could see volatile trading come expiry day.
The Bottom Line
Quadruple witching is unlikely to interfere with most investors’ plans so long as they are aware of the potential for widened bid-ask spreads on this above-average trading volume day. The simplest way to avoid any risk altogether is to avoid placing trades on this day if you’re uncomfortable trading in a volatile environment. Remember that sometimes the best trade is doing nothing at all.
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