Four times a year an event occurs in the market that results in substantially increased trading volume and volatile price action in the market. This is the triple witching that happens on the third Friday in March, June, September, and December. What is triple witching? This is the day that three kinds of equity derivatives expire all at once. Stock options, stock index futures, and stock index options contracts all expire at the same time. Trading activity increases as traders close or roll out of trade, offset positions that are expiring going into the last hour of trading on triple witching day.
Why Does Volume Go Up During the Triple Witching Hour?
Volume goes up due when options are closing and more of them go up on triple witching because more options are closing on these days four times a year than during other months. When options are allowed to expire this can require the sale or purchase of an underlying security. And traders who have no desire to buy or sell a security will close, roll out of, or offset their positions during or at the end of the trading day. And more do this on triple witching day and especially during the last hour which is called the triple witching hour.
Not only does trading volume rise as traders finalize positions before the end of triple witching day but market volatility goes up as well as traders are commonly somewhat forced to make trades constrained by time and without the ability to let a trade sit a day or two to see what happens. Futures positions are commonly offset as triple witching day comes to an end. These contracts mandate that the buyer purchase the underlying and that the seller sells it. Traders who wish to hold positions for longer time frames will sell the contract to close it and then purchase another for the following time period. Thus traders making new trades can drive volatility on triple witching day.
Triple Witching Day and In the Money Options Contracts
Once an in the money option contract expires a trader may be required to provide the underlying equity to the buyer, which means either handing over stock that they own or buying at the current market price. To avoid this situation a trader can close their position before expiration up until the end of the trading day. Either way this results in a trade of an option contract or a trade of a stock. Puts that are in the money and calls that are in the money both present this issue as option traders typically do not want to own the stocks in question but simply to trade options so they will make the appropriate trades in order to exit their option contracts before expiration on triple witching day.
Triple Witching Day Arbitrage
The vast majority of trades on triple witching day are carried out by traders who are closing, offsetting, or opening contracts. However, because this uptick in activity causes rapid price discrepancies across the market, there are traders whose only reason for trading on triple witching day is to act as short-term arbitrageurs. They swoop in and profit from price variations across the market by buying and selling at precise points in time for small but recurring profits. This practice requires extreme skill as large, round trip trades need to be carried out in mere seconds.
What to Expect on Triple Witching Day
It is common on triple witching day to see a hefty increase in trading volume as well as excess volatility. Because of gamma hedging, securities may tend to move toward strike prices with large open interest. The problem that confronts traders is called pin risk in which traders become unsure of whether or not to exercise profitable long positions when they are not sure if their short positions will be assigned.