As Halloween approaches, scary images come springing to our minds – few (if any) of which include images from the world of finance and investment. However, there is an often heard, but little understood, event that occurs four times a year on Wall Street (stocks) and Chicago (options and futures) called “Quadruple Witching”. As we get ready to celebrate Halloween, I thought it would be good to explore in more detail what this “Witching” is all about.
In “Part I”, we covered many of the basics about “Quadruple Witching” with our expert: Ron Haydt, Vice President of MarketTamer.com. In this continuation of our interview with Ron, we will elaborate on why “Quadruple Witching” is important to all investors – big and small.
Tom: Hi, Ron. Let’s pick up where we left off last time. You were explaining that big funds and professional traders need to “balance out” the option and futures positions they hold against their big portfolios, and the resulting increased volatility (wide swings in stock prices) can wreak havoc among those who are uninformed and unprepared.
Ron: Absolutely, Tom. This “Witching” week trading environment is treacherous for long-term investors. As the “Witching Hour” comes closer, there is a huge “dis-connect” between long-term fundamentals and short-term portfolio balancing. During the prior weeks, professional traders/funds have hedged (offset) some of the risk in their portfolio by using Futures, Index Options, Stock Options and/or Single Stock Futures.
T: Can you explain that further?
R: This means that if the portfolio is net “long”, they hold “short” hedge positions. So their options or futures position in place during “witching” week is bearish. But in order to “balance out” by the end of the Freaky Friday’s “Witching Hour” (and not be required to accept “delivery”) they absolutely need to “buy back” that bearish position. Obviously, that actually makes the underlying stock security look “bullish”… but that can be only a temporary movement that will be reversed the following week. Depending upon how large these various positions are being traded by professionals and big funds, the price movements during “Witching” week and “Freaky Friday” can be quite large
T: Pretty scary, Ron. No wonder it’s called “Witching”!
R: The scale of all of this can be huge. imagine numerous large traders (Hedge Funds, High Frequency Traders, and Arbitrageurs, etc.) each having different positions and trying to unwind each large trade… all of a sudden you have opposing forces pulling at a Stock , ETF, Future, Index, etc. — with absolutely no bearing on “fundamentals”. In those moments, all that matters is how that particular trader needs to balance their portfolio! All of this activity takes place during every hour and minute leading up to the close of trading on Freaky Friday!
T: I’ve noticed that volume zooms during “Witching Week”.
R: That is correct. Freaky Friday often creates a massive rise in volume due to the heightened trading activity I have described. This can be misleading for traditional, longer term, “fundamental” investors as well. As the typical investor looks at stock charts, when volume rises, it is interpreted as a reliable indicator that the current “price movement” is believable—particularly important when a stock is reversing direction, higher or lower, on strong volume.
So if such a trader is unaware of Witching Week and Freaky Friday, he/she can misinterpret a spike in volume, when accompanied by a large price movement, as a sign that the stock or index being studied is reversing, higher or lower. If the investor then acts on that market interpretation, significant disappointment and frustration can result in the days that follow.
T: Sounds like the market needs a warning label on Freaky Friday: “Trading on price movement today can be hazardous to your portfolio!” Of course, I am joking. The government would never do that. But it is true.
R: You are correct, Tom. If an investor doesn’t become familiar with the market dynamics of Witching Week/Day/Hour, they can lose money. It might be best for long-term, fundamental investors to be extremely cautious during those weeks. The manic/schizophrenic /irrational price movements often seen during those weeks is a “game: best left to the professionals, the big funds, and those who consider themselves short-term traders.
T: This has been very illuminating, Ron! It is scary, but this explanation can be most helpful to the “average” investor. Thanks so much for your time!
R: You are welcome, Tom!
T: If you want to contact Ron, go to http://www.markettamer.com/ContactUs