What is Quadruple Witching

Quadruple witching or quad-witch is an event in timelines of derivatives contract expiration, where all the four classes of derivatives instruments viz: index futures, index options, stock futures and stock options expire on the same day at same time. The expiry is an important event in the lifetime of derivatives contracts as it often coincides with settlement and exercise of the contract. The expiration is usually marked with increased trading activity as traders or investors try to square-off the existing positions or roll-over into next month.

According to the folklores in the west, the “witching hour'' is that time of the day when supernatural activities and evil things happen, unhindered.  During such expiration the volatility can be high and prices might plunge making a period of wild activity, just like the “witching hour”.

How it works

The date or day of expiration varies for all exchanges around the world. Some exchanges prefer settlement and expiration on the last day of the calendar month, while other exchanges have structured the contract expiration to coincide with a particular day of the week and month. For eg: Thursday for weekly expiry and last Thursday of the month for monthly expiries on National Stock Exchange, India. Whereas, in US – the exchanges denote last day of the week, Friday and last Friday of the month as expiry and settlement day 

Quad-witch is viewed by some market participants as a “perfect storm” as the last few trading hours before the close and settlement brings in excessive volumes and liquidity in the above-mentioned derivative segments, resulting in an increase in market volatility and traded volume. While increase in liquidity is preferable, sudden increase in implied volatility just before settlement can cause major pain, especially to the short option positions. 

Impact

Quad-Witching is also the time when arbitrage opportunities arise on seemingly frequent basis. The overactive derivative counter and stable prices in underlying assets causes pricing distortion. This gives a widely predictable opportunity to the arbitrageurs. If the quad or triple witching coincides with an important national or international financial news event, then the whiplash of increased volatility and price gyrations can be impacted for next few trading sessions. For eg: announcement of monetary policy or interest rate hike or cut on the last trading day of the calendar contract.

Real world evidence

On 15th March 2019, Reuters had reported that on the first quad-witch day of 2019, the US exchanges registered a traded volume of USD 10 Billion, compared to USD 7.5 Billion averaging over the last 20 days before expiry. There was a significant increase of 25% in trading volume in a single session. The markets after that day traded higher for at least a week, leading to all major indices gaining over 1% on account of additional liquidity.