By Chris Ebert
These days, there are lots of different options expirations available, so no single expiration is quite as important as it may have been in the past when availability was much more limited. Even so, some options expiration dates, such as September 20, 2014 are more significant than others because they coincide with expirations of other derivative contracts, namely futures.
When the expirations of options and futures coincide – generally on the third Friday of March, June, September and December – the effect on the stock market can be magnified. The term witching is often used synonymously for the final hour of expiration. Triple-witching or quadruple-witching simply refers to the number of options or futures expiring at the same time.
Witching occurs this Friday, September 19.
To understand the potential effects of witching this week, it may be helpful to take a look at the reasons that options expiration can affect stock prices. Once the reasons are known, it should become easier to notice the effects, thus allowing trader to differentiate those effects, which are generally temporary, from the effects of broader-market forces, which may be more permanent.
Nobody likes to be stopped out of a stock during witching only to have the stock reverse when the effect of witching disappears the following week. The following analysis looks specifically at this Friday’s options witching on the S&P 500. To begin, it is important to know what types of options are currently profitable.
* All profits are calculated at expiration, as a percentage of the underlying SPY share price. SPY is an Exchange Traded Fund (ETF), the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) that closely tracks the performance of the S&P 500 stock index. All options are at-the-money (ATM) when-opened 4 months (112 days) to expiration. (e.g. Profit of $6 per share on an expiring Long Call would represent a 3% profit if $SPY was trading at $200, regardless of whether the call premium itself actually increased 50%, 100% or more)
You are here – Bull Market Stage 1 – the “Digesting Gains” Stage.
On the chart above there are 3 categories of option trades: A, B and C. For this past week, ending September 6, 2014, this is how the trades performed on the S&P 500 index ($SPY):
- Covered Call and Naked Put trading are each currently profitable (A+).
This week’s profit was +2.6%.
- Long Call and Married Put trading are each currently profitable (B+).
This week’s profit was +1.9%.
- Long Straddle and Strangle trading is currently not profitable (C-).
This week’s loss was -0.8%.
Using the chart above, it can be seen that the combination, A+ B+ C-, occurs whenever the stock market environment is at Bull Market Stage 2, known here as (more…)