Triple witching is the simultaneous expiration of stock options, stock index futures, and stock index options contracts.
Mechanics of triple witching
For Elephants trading in the United States, triple witching occurs four times a year on the third Friday of March, June, September, and December. While the term is specific to US financial markets, many international exchanges have similar overlapping expiration schedules for their regional derivative products. On these specific dates, the legal contracts governing stock options, stock index futures, and stock index options expire at the exact same time.
When derivative contracts reach their expiration date, traders are forced to either close out their open positions or roll them forward into a new contract with a later date. This mechanical process requires market participants to buy or sell the underlying equities to settle their financial obligations. The simultaneous settlement of three distinct derivative markets generates a measurable increase in total daily trading volume.
Arbitrageurs trade heavily on these days to capture minor price discrepancies between the expiring derivatives and the actual stock prices. Institutional investors also use the expiration dates to rebalance their large index funds. The bulk of the trading volume concentrates in the final hour of the regular trading session – referred to as the witching hour – and can cause short-term price volatility. The expiration event is strictly mechanical and does not change the financial health or valuation of the underlying companies.
Example
Suppose you are an Elephant holding stock options for a public company called Savanna Waterworks, an agricultural firm that engineers irrigation systems for grazing lands. On the third Friday of September, your options contracts are scheduled to expire. On that same day, large hedge funds hold expiring stock index futures and stock index options for a broad agriculture index that contains Savanna Waterworks. To settle their index derivatives, the hedge funds must aggressively buy and sell shares of every company in the index. When you execute your trade to exercise your options, your order overlaps with the massive institutional block trades. This localized event causes the trading volume of Savanna Waterworks stock to spike dramatically right before the market closes.