HEAD OF DERIVATIVES, GFT
LAST Friday saw the quarterly event that is known in the markets as “quadruple witching”. It’s when we have the combined expiry of US index futures, index options, stock futures and stock options, all on the same day. The haunting moniker that is attached to this infamous occurrence suggests a certain mystique, something one should be wary of, insinuating as it does some kind of heightened state of volatility. Something to steer well clear of then, surely?
Well, certainly, if you have a CFD position in a US stock index future such as the Dow, the S&P or the NASDAQ, and you decide to leave the position open to expire at the official settlement price of the market on this third Friday, there is risk to be aware of. Not only can you not trade out of your position on this day, the expiry price of these markets – at which your trade will be automatically closed – is calculated based on a process which results in a Special Opening Quotation (SOQ).
Without going into too much detail, this SOQ is derived from the prices of each constituent stock of the index as if they had all traded on the opening of the market at the same time – which in reality they never do – and as a result can be some distance away from where the actual index actually trades that day.
Certainly all this can cause the inexperienced trader to be caught out amid the confusion of the expiry price process. But this is merely a perceived volatility as a result of a rather complicated expiry calculation. Are indices are actually more volatile on quadruple witching day?
The logic here is that a frenzy of activity can be expected as futures and options traders battle to either square up their derivatives positions, or attempt to sway the market in order to keep their options in court. It’s debatable though. Volumes do usually pick up and sometimes we do seem to get sudden swings in the market, which are often attributed to the witching, somewhat dubiously though it could be said, by headline-hungry media. Maybe they’re right, or maybe it’s a self-perpetuated kind of volatility, or maybe it’s just a coincidence.
What we are starting to see more and more of however is that most of the increased activity associated with expiries is being seen earlier in the week rather than on the third Friday itself. The bottom line of all this is that traders should be aware of the heightened readiness for more volatility in the “witching week”.
One piece of market trivia to finish on: the Dow finishes up on the day on “freaky Friday” around 65 per cent of the time. How… bewitching.