Greetings Traders, and welcome back to another Survival Guide.
Chris here, bringing you some more information that will hopefully
allow you to progress further along your trading career,
whether you're just trying to get better or you're trying
to pass the ultimate challenge and get through the Gauntlet Mini.
Either way, today we're gonna be discussing quadruple witching.
It sounds spooky, and the events of the quadruple witching days
are relatively spooky themselves.
We see volatility and volume change, and we're gonna talk
all about that and more as we get going.
But before we do, please do me a favor, click that like and
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content for you all out there.
Now let's dive into quadruple witching.
Depending on how you look at it, the financial markets can
definitely be a spooky place, but the term that we're talking
about today is called quadruple witching.
You might also hear it as the quadruple witching day or
the quad witching day or the quadruple witching hour.
At the end, it all means the same thing.
We'll start off with covering exactly what those terms are referencing.
Quadruple witching is a term that is used to describe the
days of the year when single stock futures, single stock options,
stock index futures, and stock index options are expiring.
The more important thing is the scale at which this happens.
All four asset classes expire simultaneously once per quarter.
On the third Friday of March, June, September, and December
at the market close, which is 4:00 PM Eastern Time.
As a result, hundreds of billions of dollars worth of contracts
expire simultaneously on the same day.
This significant market event is named after the centuries-old
folklore myth that after witching hour at midnight,
supernatural beings start roaming the Earth and causing chaos
and destruction.
Anybody unfortunate to encounter them is usually said to
suffer from bad luck.
Now that we know what quadruple witching is and where its
name comes from, it's really not that hard to probably guess
how it's impacting the market
in a generality. Years of historical market data show that
the quadruple witching days can substantially increase volatility
and sometimes wreak havoc on the market.
While this isn't always the case, it is essential to know
that the markets might be unstable around those particular dates,
which is one of the reasons why we care.
Quadruple witching is the biggest among all the witching events,
which also include double witching, which is when
two asset classes are expiring at the same time, and triple witching,
which is, naturally, when three of the four markets
are expiring simultaneously.
There are a few basic principles that we should remember
to be better prepared around those quad witching events.
The most significant effect of quadruple witching on the market
is the increased trading volume surrounding that particular period.
The reason is that many market participants face
the urgent need to deal with their open positions.
Some might offset existing futures and options contracts
that are profitable at the prevailing market price.
That way, they can settle their loss or gain from the purchase
at the current market price.
Others might choose to extend the contract to roll it forward,
as they say, by offsetting the existing trade and simultaneously
booking a new option or futures contract to be settled in the future.
All these market moves usually result in increased trading
activity. This chart is an estimation of the average value
on quadruple and standard days throughout 2015 to 2020 on the Nasdaq.
While the vast trading volume is usually considered a sign
of a healthy market environment, there might be situations
where it leads to price abnormalities.
For example, a window of increased trading liquidity can
make it complicated to tell whether a stock's price movement
is driven by option expiration events or by changes in business
fundamentals. Based on the buying and selling dynamics and
the dominant positions, the market can experience increased
volatility. The full extent of its volatility depends on
various factors, the first of which is the number of traders
that want to offset their contracts.
The second is the way they want to do it.
One example is called the long gamma condition, where options
traders go against the trend instead of hedging their positions.
The last option here is that we have to consider the
events in the build up of the quadruple witching day itself,
even if it isn't because of the quadruple witching day.
Quadruple witching involves four types of instruments.
We have a single stock options futures contracts,
single stock futures contracts, index options contracts,
and index futures contracts. Starting off at the top of the single stock options contracts,
stock options contracts are derivatives, which means that
their value is based on an underlying security.
Options contracts give the buyer the freedom to choose whether
they want to complete a transaction for the particular instrument
before a specific date and a predetermined strike price or not.
There are two types of options, calls and put.
The call gives the holder the right to buy a stock, while
the put gives the holder the right to sell the stock.
Then we have the single stock futures contracts,
and futures contracts are agreements to
buy or sell an asset at a predetermined price in the future.
The future transaction date is specified.
Futures contracts are standardized instruments, and they
do trade on futures exchanges.
Upon a futures contract agreement, the buyer is obligated
to buy while the seller has to sell the underlying asset at expiry.
Then we have index options contracts.
Index options contracts give you the right, but not the obligation
to buy a whole index like the S&P 500 or the Dow Jones Industrial Average.
Index options contracts resemble what ETFs do by
making it easy to get better diversification by "buying the market."
These instruments are cash settled and don't give you the
ownership of the index constituents.
Finally, we have the index futures contracts. The difference
between the index futures contracts and the single stock futures contracts
is that the index futures allow us to buy
a whole index instead of just shares of a single company.
The profit and loss of these instruments are calculated when
the existing position is offset.
The index futures contracts are often used by investors willing
to speculate on the direction of the particular index.
They are also suitable instruments for investors willing
to hedge a portfolio of separate stocks.
The dates. These are the witching dates.
If you need to pause the video and write them down, feel free,
but we start off in 2021; March 19th, June 18th,
September 17th, December 17th.
Then we work our way to 2022 where it's going to be March
18th back a day, June 17th, September 16th and December 16th.
In 2023 will be March 17th instead of 18th, June 16th
instead of 17th, and then September 15th and December 15th.
If you are wondering about the dates and you want to be
prepared for that witching hour, then here it is.
Pause the video, write it down.
Quadruple witching is crucial,
if we're a future trader or option trader and we don't know
what's happening and we're involved in the markets. It could
be terrible or it could be very beneficial if our strategy
is favoring that increase in volume.
Quadruple witching is also essential for other market participants as well.
The reason behind that is that it might simply distort their
market information for whatever particular instrument they're
looking at, and it can result in that increased volatility,
and they may not know why.
In a nutshell, quadruple witching is something that we need to be aware of.
Even if we don't choose to be involved in it,
it doesn't matter, or the need to be aware of it
doesn't change, due to the fact that it's coming,
whether we like it or not.
If we're trading during the quadruple witching events
and we're not prepared, it can definitely catch us sideways.
On this chart of the S&P 500, in the 15 days before and
after the quad witching day, we can see some pretty interesting
happenings. The chart shows that the index typically rallies
from the 6th day to the day before the Quad Witch day.
On the day itself, the market usually declines.
However, the trading that is going on is far more aggressive,
and the market isn't necessarily friendly for beginners during this stage.
The quadruple witching events are moments when
arbitrage traders thrive. Due to the increased volatility, high frequency
trading firms or algorithmic traders capable of quickly exploiting
price discrepancies among several markets and instruments,
they usually dominate the market, further increasing the trading volume.
The chance is you probably aren't one of those guys with
millisecond trading infrastructure at home, but the truth is,
that even in that case, we still can benefit from quadruple witching days.
While capitalizing on the temporary price distortions probably
won't be on the top of your plan,
it is essential to, first of all, hedge our positions when
these events occur.
We want to make sure that we're aligned with our predefined
risk management strategy as well as our profit targets.
That way, we can make our best decision for each of our positions
when the quad witching event is happening.
Even if we don't want to get too deep into the water, being
prepared for these events and having a plan of action will
allow us to respond quicker, which increases the likelihood
of a more favorable decision.
Whether that means getting in and taking advantage of a move
before it occurs, or that means getting out of the way because
we were prepared and responded in a fast enough manner that
we didn't expose ourself any longer than we wanted to.
We don't want to allow ourselves to be greedy.
It can be very enticing if we're trading during a quad witching
event and it's going in our favor.
It can very quickly be getting deep deep into the money,
and we might want to keep that going well beyond our predetermined
take profit level.
But the reality is this is just being biased by greed, and
this can be the downfall of an entire position that is
already in the profit and turn it into a losing one.
In conclusion, the quadruple witching event is an event
where we will see changes in both volume, volatility, and even liquidity.
It's a time where the market will behave differently than
your status quo day.
Regardless of whether or not you're looking to trade
the quadruple witching event, it's more important to just
be aware that it's there so you can actually make that choice
yourself. There's nothing worse than waking up and trading
the day with your strategy and having your trades open just
as you would on any other day without realizing the market's
about to get pretty spooky.
But until next time, folks, I look forward to seeing you all soon.
Keep it up out there. Best of luck in the markets.
Over and out.