Stocks have been on a wild ride this week, and conditions could still get weirder as traders brace for “quadruple witching” on Friday, when a flurry of equity options and futures contracts expire.
In particular, options contracts tied to $4 trillion in stocks, stock-index futures and exchange-traded funds are set to expire, making Friday potentially the busiest day for options traders this year, according to data compiled by Rocky Fishman, the head of index volatility research at Goldman Sachs.
The term “quadruple witching” denotes days when a host of equity-linked options and futures contracts expire, as TradeStation explains. It only happens four times a year, once every quarter.
Additionally, the largest slug of equity options expire in December, and this year is no exception, Fishman said, as the $4 trillion expiring on Friday is the largest options exposure heading into expiry since at least the start of the year.
Reliance on options by both retail and institutional traders has surged this year as traders have increasingly turned to short-dated contracts to try to capture profits from large, last-minute swings in the days and hours before they expire, according to Callie Cox, U.S. investment analyst at eToro.
“We’ve seen a lot of retail customers look toward options in thinking about how to hedge and speculate toward the end of the year,” Cox said, adding that Friday was “going to be a very big options expiration.”
Options tied to $2.4 trillion in S&P 500 index futures are expected to be the main event on Friday, according to Brent Kochuba, founder of options analytic service SpotGamma, as hundreds of thousands of contracts with strike prices concentrated around the 4,000 level are set to expire.
Puts and calls on the large-cap index are “very concentrated at the 4,000 strike,” Kochuba said in comments emailed to MarketWatch, adding that recent turbulence in markets suggests traders may be underestimating how volatile markets might be heading into the end of the year.
Low levels of liquidity, typical during the latter half of December, could further exaggerate swings in stocks as options dealers scramble to adjust their positions accordingly, said Garrett DeSimone, head quant at OptionMetrics.
“Large notional expirations can cause turbulence especially during periods of heightened volatility or constrained liquidity. When large amounts of gamma are shed through expiration, market makers have to undergo significant rebalancing to adjust their delta hedges. This can cause a short-term destabilization in markets, leading to higher volatility,” DeSimone said.
U.S. stocks tumbled on Thursday, with the Dow Jones Industrial Average DJIA,
United States Oil Fund exchange-traded fund is often mistaken as a proxy for tracking oil.
Joseph Adinolfi is a markets reporter at MarketWatch.
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