Back in the 1980s and 90s when JJ Kinahan, chief market strategist for TD Ameritrade, traded in the storied Chicago futures and options pits, there were certain days he had to be more wary than usual about potential risk to his pocketbook.
Those were the so-called “triple witching” sessions, which come up every quarter as contracts for stock index futures, stock index options, and stock options all expire on the same day, often triggering a rush among market participants to roll over risk. The volatility that rocked the markets on those occasions could also be a trader’s best friend, because professional traders tend to thrive in markets that rise or fall dramatically.
Volatility = Uncertainty = A Double-Edged Sword
But the volatility associated with triple witching sometimes meant not being 100% certain of your position going into the weekend. If, for example, the index fluctuated around an options strike in which you held a short position, you might not know whether (or how many) of those options would be assigned to you.
And remember, we’re talking about the days before electronic order matching; every trade detail—counterparty, price, quantity, and contract month—was negotiated in a pit, and not all the information matched up.
Witching could also be tough on the average retail investor, who didn’t typically enjoy access to the same information as traders on the floor.
From his current perspective as chief market strategist for TD Ameritrade, Kinahan can look back fondly on those times. The triple-witching situation today is far less frightening for retail investors, but that doesn’t mean all the risk has gone away. There’s still reason for the average investor to watch out for witches.
Once an Advantage for Pit Traders
“It was great when it was in its heyday,” Kinahan said, discussing his memories of triple witching back when he was a young trader in the pits. “As a market maker, it was fantastic because you held a lot of information and had a lot of knowledge as to what was trading. It was a very volatile few days with lots of opportunity.”
The volatility would often start a day or two before expirations, and last right up to the closing minutes, he recalled. Pit traders held a big advantage at the time because they had a physical presence at the point of price discovery. “When I was a young pup, we’d see the order flow,” Kinahan remembered. But even pit traders sometimes suffered nasty surprises.
“Today, market-on-close orders have to be in by 3:40 p.m. ET,” Kinahan said. “But back then there weren’t any rules, so big orders would go in with a minute left, and you could have giant moves with one minute left.”
Retail investors at the time had no access to the order flow, and risked sharp losses if they held positions into the close, Kinahan said. Although triple witching occurred only once a quarter, options expiration at the end of each month was another day that put retail investors at a disadvantage.
Newer Rules and Technology Smooth the Process
Rules put into place since then have smoothed out the process a great deal, and technology also helps protect retail investors against the more dramatic impacts of witching.
- The rule Kinahan cited about market-on-close orders being due at 3:40 p.m. ET—20 minutes before the New York Stock Exchange’s closing bell—means there’s less chance of a last-minute shock.
- Another development that has helped calm things down is the availability of weekly options, which allow more opportunity to roll over risk, Kinahan said. This tends to smooth out the process.
- Additional products in the mix have also helped cool off the market over the years, including the advent of exchange-traded funds (ETFs). “You used to have less product selection in general, with no ETFs,” Kinahan recalled. “Everyone relied on a few main indices and futures. It was a very narrow set of products and time frames, which meant everything happened in an exponential fashion.”
- Electronic trading technology means any trader with the right tools can now have as much access to the order flow as Kinahan did when he was in the pits, leveling the playing field to some extent. And orders are matched in real time and sent directly to the clearing house, so errors are generally rectified in short order.
“As a retail trader, the fact that it’s different now is a much better thing,” Kinahan said. “Electronic trading has evened the playing field so the retail trader has a fair shot and can manage risk. All orders are now electronic, so it’s not just traders in a pit. Markets are more efficient, and swings are less dramatic in the last few minutes of the day.”
Retail Investors Still Need to Be on Their Toes
All that said, triple witching (now quadruple witching since the advent of single-stock futures in 2002) still occurs on the third Friday of March, June, September, and December, and those remain days when investors might want to exercise special care, just as Kinahan did in the pits long ago.
“I still think you have to be aware of it,” Kinahan said. “But the good news is there’s no disadvantage for the retail trader on those days. At every expiration, you should have a heightened sense that there might be more movement at the open or close as people unwind baskets of stocks or futures. On every expiration you should be aware, and on quadruple witching, you have to be more aware.”
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