By Chris Ebert
With Triple-Witching coming up in a few days, as it does late in March, June, September and December every year (the expiration of several Futures and Options contracts near the same date) many traders of those contracts will be “working for the weekend”.
If equity or commodity prices have risen or fallen substantially, sellers of many derivatives contracts will be obligated to take actions to protect their portfolios – most notably by buying the underlying root of the contract so that they can deliver the promise made in the contract.
While futures contracts generally have very good liquidity, allowing traders to exit expiring contracts with ease, options contracts often do not have such liquidity. As a result, options sellers can find themselves in a peculiar dilemma in which they must buy or sell stocks to meet the obligation of an expiring options contract.
A Call option seller, for example, could be required to hand over 100 shares of the underlying stock at Triple Witching this coming week, provided that option expires in-the-money. Whether the option expires in-the-money or not will depend upon the closing stock price this coming Friday. When stock prices rise, Call options contracts tend to end up in-the-money.
If the weekend comes without an increase in prices, many of those derivatives will expire worthless. But if there is an increase in prices, derivative sellers, particularly equity Call options sellers, could be compelled to purchase stocks to meet the obligations of their contracts.
It stands to reason that the following week will be one that is controlled by derivatives. Although news will likely act as the initial catalyst to drive stock and commodity prices in the following week, the reaction from derivative sellers could determine the final outcome.
Any large increase in stock prices could fuel an increase in buying of equities by Call option sellers needing to meet their obligation prior to Triple Witching. That would serve to bolster an already-existing rally. By the same token, any significant sell-off could cause Put option sellers to sell or short stocks in order to have the financial capacity to have stocks “put” on them when those contracts expire at Triple Witching; and that could make a sell-off more intense than it otherwise might be.
The end result is that whichever way stocks move this coming week, derivatives are likely to exacerbate that move. Options and Futures are no more likely to drive the market this week than any other week. But, whichever way the stock market ends up going, these derivatives could certainly make the move much bigger.
Big moves happen quite often near Triple Witching, as is to be expected when derivatives traders are compelled to buy or sell to meet contract obligations. It is quite possibly the cause of the recent volatility that sent the Dow up and down hundreds of points in recent weeks – traders of derivatives buying or selling in the days leading up to Triple Witching in order to meet their obligations.
Whatever the outcome, by this time next weekend all of the major expiring derivatives will have been settled. Triple Witching will be over. Many stocks will find themselves in new hands upon settlement; and that will set the stage for the stock market in October and the remainder of 2016. It has a lot to do with whether those stocks end up in the strong hands of folks who really wanted to own them or whether they end up in the weak hands of options traders who just wanted to get a quick profit and get out.
At the moment, every trader is working for the weekend.
The preceding is a post by Christopher Ebert, author of the popular option trading book “Show Me Your Options!” Chris uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. Questions about constructing a specific option trade, or option trading in general, may be entered in the comment section below, or emailed to OptionScientist@zentrader.ca
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