The witching hour signifies the last hour of trading on the third Friday of each month, when options and futures on stocks and indexes expire. This crucial period often witnesses heavier trading volumes as traders wind up options and futures contracts before their expiration. Subsequently, positions are usually reopened in later-expiring contracts.
Key Takeaways
- Defining the Witching Hour: The final trading hour before options and derivative contracts expire.
- Volume Surge: The period typically sees higher trading volumes as investors rush to close or roll their positions.
- Double and Triple Witching: These terms refer to the expiration of two or three types of derivative contracts on the same day, respectively.
Unveiling Witching Hours
The witching hour is the last trading hour before the expiration of derivatives contracts. Traders frequently refer to terms like “triple witching,” which denotes the simultaneous expiration of stock options, index options, and index futures, occurring on the third Friday of March, June, September, and December.
When single-stock futures traded in the U.S. from 2002 to 2020, their quarterly expiration on the same dates resulted in “quadruple witching.” Double witching happens on the third Friday of the months without quarterly expirations, involving the expiration of stock and index options.
Trading activities during monthly witching hours primarily involve rolling over or closing expiring contracts to avoid holding the underlying asset at expiration. Imbalances from such trades sometimes create price inefficiencies that arbitrageurs leverage.
Reasons to Offset Positions
The main reason for the heightened activity on witching-hour days is that open contracts at expiry could necessitate buying or selling the underlying security. For instance:
- Futures contracts: Sellers must deliver the specified quantity of the commodity to the buyers unless the contract is closed before expiration.
- Options contracts: “In-the-money” positions (profitable) mean the underlying asset might be exercised and assigned to the contract owner.
To avoid this, traders often roll out or forward their expiring contracts, i.e., closing existing positions and replacing them with ones expiring at a later date.
Opportunities for Arbitrage
The witching hour invites many trading opportunities due to potential price inefficiencies from the increase in trading volume. Traders look to capitalize on minor price discrepancies:
- Opportunity Scenario: Contracts representing extensive short positions might be bid higher if traders believe they’ll be bought to close positions before expiration.
- Arbitrage Play: Traders may sell contracts at elevated prices and close them out later to profit or buy on the upswing and sell when demand ebbs.
Exploring Triple and Quadruple Witching
Triple and quadruple witching days mark the concurrent expiration of three or four derivative contracts such as stock index futures, stock index options, single-stock options, and options on stock index futures. Although triple witching occurs four times yearly, quadruple witching is rarer.
Triple-Witching Dates
Occurs on the last Friday of each trading quarter (March, June, September, December):
- 2023 Date: Dec. 15
- 2024 Dates: March 15, June 21, Sept. 20, Dec. 20
During these periods, trading activity typically spikes as market participants rush to manage positions before deadlines, culminating in highly volatile final trading hours.
Why Does Volume Spike During the Witching Hour?
Expiring contracts across various asset classes simultaneously trigger increased trading. Investors push to close or roll over positions, speculate on last-minute volatility, dynamically hedge, and exploit fleeting mispricing opportunities. All of this leads to a notable surge in trading activity.
Why ‘Witching Hour’?
In folklore, the ‘witching hour’ refers to a time at night, often midnight, associated with supernatural occurrences. The financial term likely derives from the intense flurry and unpredictability of the stock markets at the end of trading, akin to the chaotic nature attributed to this mystical nighttime hour.
Other High-Activity Trading Hours
- Market Openings: Following the opening bell, there’s heightened activity as traders respond to overnight news.
- Market Closes: The last trading hour sees increased transactions as investors wrap up their day.
- Inter-Market Overlaps: Trading volume spikes when major global markets, like New York and London, are simultaneously active.
- Economic Data Releases: Significant economic reports can trigger substantial trading activity.
The Final Perspective
In summary, the ‘witching hour’ stands as a dramatic period in financial trading due to the expiration of various options and futures contracts. This hour brims with heavy trading volumes and increased market volatility as investors, arbitrageurs, and speculators act before markets close. Double, triple, and quadruple witching days amplify these dynamics, marking notable calendar dates for all market participants.
Related Terms: trading volume, arbitrage, derivative contracts, market open, market close.
References
- NASDAQ. “The Powerful Impact of ‘Triple Witching”.’
- A . Gottesman. Derivatives Essentials: An Introduction to Forwards, Futures, Options and Swaps. John Wiley & Sons, 2016. Chapter 2-3.
- D. Loader. Clearing, Settlement, and Custody. Elsevier Science & Technology, 2019. Pages 85-90.
