“The Witching Hour” sounds like a bad public access television show, but it really refers to a particular time of day where odd and unexplainable things happen. When referring to stocks, it means pretty much the same thing, except that the reasons behind the activities are somewhat explainable.
Triple-witching days occur four times a year in the stock market, on the third Friday of March, June, September, and December. On those four days, three different types of contracts all expire – stock futures, stock options, and stock index options. Expiration was typically during the last hour of the trading day – hence the witching hour – but that is not necessarily true anymore.
Because of this, thousands of traders around the globe are placed in the position of acting on their contracts on the same day — creating intense volatility in the market. Sometimes it is known as a quadruple-witching day thanks to the expiration of individual stock futures options, which were added in 2001.
Futures and options are contractual arrangements pertaining to the purchase of a given asset at a future date and price prescribed in the contract [LINK TO OPTIONS 101]. The asset can be anything from stocks to commodities to currency. Futures obligate an investor to buy, whereas options provide the right to buy — without the requirement.
As the contracts move closer to their expiration dates, investors have decisions to make based on the current price and their expectations of the change. They are often able to repurchase the contracts (otherwise known as rolling) for yet another future date and price – or they may decide that the price is going to be too high for the next contract and decide to purchase the asset instead. Price, of course, is dependent on demand, which is determined in part by the contract actions of traders.
Since everyone holding futures and options contracts have to change their position and close out their contract one way or the other, the volatility is often intense on the last day. Trading volume rises by definition, and traders react to the prices as they change during this volatile period before the closing bell.
Some traders have backed away from triple-witching day, intentionally settling their contracts earlier in the week – thus the effect is starting to be spread over several days prior.
Within these triple-witching days, there have been difficult to explain trends – such as the fact that after the June triple-witching day, the Dow has suffered losses in 21 of the last 24 years heading into 2014. Would 2014 follow suit and make it 22 of 25 years? Indeed, it would. The Dow closed at 16,947.08 on Friday June 20th and at 16,851.84 on Friday June 27th. It was not much of a loss, but it was a loss just the same.
What did that loss mean? Not much of anything. The Dow surpassed the triple-witching day value by Tuesday, July 1st, on its way to new record highs.
So how should you approach triple-witching days? For the majority of investors, the answer is: don’t. Kick back and let the day go by, and the days immediately surrounding triple-witching days should be approached with caution.
If you are a long-term investor, there is no reason for you to trade on this day because the chaos usually sorts itself out within a short time and investments return to normal. If you are a day trader, you need to be skilled, experienced and insightful to profit on triple witching days and then cackle all the way to the bank.