Abstract: Four witch days are market fluctuations that may be caused by the simultaneous expiration of four major derivatives contracts. The trading volume on the Fourth Witch Day is generally high, but it may not cause large price fluctuations unless it coincides with a major event in the global economy.
What is Quadruple witching?
“Four witches” refers to the date when the four major derivatives contracts in the US market expire at the same time. These four contracts are stock options, stock futures, stock index futures and stock index options. Four Witch Days occur four times a year, on the third Friday of March, June, September and December.
Futures and options are derivatives linked to stock prices. When derivatives expire, traders must close or adjust positions. This could trigger huge trading volumes. Market activity during these trading days typically peaks during the last trading hour, also known as the “Four Witch Hour.”
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What are the four derivatives of the Four Witch Days?
Before introducing the impact of the Four Witch Days on the market in depth, let’s take a look at the introduction of these four major derivatives contracts:
1. Stock Options
Stock options are stock-based derivatives. It allows a buyer to legally buy or sell stock on or before a specific date at a predetermined cost (strike price) without coercion. There are two types of stock options: call options and put options. When buying a call option, if the price of the option on the expiration date is higher than the strike price, the investor can exercise the option or convert it into stock to cash out. When an investor buys a put option, as long as the stock price is below the strike price on the expiration date, the investor can profit from a drop in the stock price.
2. Stock futures
A futures contract is a legal agreement to buy or sell an asset at a determined price on a specified future date. Futures contracts have a fixed quantity and expiration date. Futures are traded on a futures exchange, and the buyer of a futures contract is obliged to buy the underlying asset at expiration, while the seller is obliged to sell the underlying asset at expiration.
3. Stock Index Options
Stock index options are similar to stock options, but instead of buying a single security, they give investors the right to trade an index, such as the SP 500 or other benchmarks. Options give investors the right to trade, not the obligation. At expiration, the index price relative to the option strike price determines the profit of the trade.
It should be noted that index options do not provide ownership of individual stocks, the transaction is settled in cash, and on the expiration date, the difference between the option price and the strike price determines the profit and loss.
4. Stock Index Futures
Stock index futures are similar to stock futures, except that investors buy or sell the underlying stock index. At maturity, existing positions are offset and profit or loss cash goes into the investor’s account. Investors use stock index futures to bet on the direction of the index, buying if they think the index will rise and selling if they think the market will fall. Index futures can also be used to hedge stock portfolios so that portfolio managers don’t have to sell their portfolios when the market is down.
The impact of four witch days on the market
The simultaneous expiration of stock index futures, options on stock index futures, single stock options and index options will result in greater volatility and volume. For example, on March 19, 2021, the SP 500 recorded its highest volume for all of last year, and the other four witch days also saw above-average activity.
SP 500 Index Trend from Early 2021-July 2022 and Four Witch Day Volumes
Investors are partly justified by fears of wild swings in the prices of the underlying assets of the Four Witch Days. But while the underlying asset traded up two-thirds of the time, only one-third of the time saw price volatility. But if a major global or U.S. event happens on or before Fourth Witch Day, price swings can be amplified quickly.
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On March 20, 2020, the first four witch days of the year, the Dow Jones closed down more than 900 points or 4.55%, the Nasdaq closed down 3.7%, and the SP 500 closed down 4.34%. There have been four circuit breakers in U.S. stocks that month, while there have only been five containment circuit breakers in the entire history of the U.S. stock market. The reason for this panic selling in U.S. stocks at the time was the outbreak of the epidemic around the world and countries shutting down their economies. However, U.S. stocks were in panic selling throughout March, so trading volumes were generally high at the time.
SP 500 Index Trend and Volume from Early 2020 to March 2021
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