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A Quarterly Tradition


Chief Strategist at Interactive Brokers

In the spirit of holiday gatherings, here is one of my recipes for volatility:

  • Start with a quarterly expiration
    • Add an FOMC meeting
    • Sprinkle in a dash of end of year position squaring
    • Shake vigorously

Yes, today is another triple (not quadruple[i]) witching expiration in the US, when futures and index options expire at the open while equity and ETF options expire at the close.  Earlier this week, we noted how there have been 4 FOMC meetings during quarterly expiration weeks, and that the S&P 500 Index (SPX) closed lower in each of them.  Quite frankly, I didn’t realize that SPX has closed lower on every expiration Friday since the Covid crisis hit:

Although a sample size of 7 is not particularly robust, it is fascinating that each of these declines occurred during a raging bull market.  Note the steady rise of the index level — it nearly doubled — during the period.  What is it about quarterly expirations that causes this counter-trend performance?

I believe that we have already explained 4 negative performances, which included the 3 worst.  The March and September 2020, and March and June 2021 expirations all occurred after an FOMC meeting.  The mood around the March 2020 expiration was particularly nasty.  Markets were exceedingly nervous, and liquidity was impaired.  It was difficult for traders to roll expiring futures and options positions, which led to some panic.  It is no coincidence that the index bottomed out on the subsequent Monday, when traders were more able to focus on the Fed’s massive injections of liquidity.  It is my hypothesis that once the bull market took root, traders were expecting dovish commentary from the FOMC statement and the Chairman and were disappointed if either failed to impress.  

The September 2021 expiration preceded an FOMC meeting where it was expected that the Fed would discuss paring its post-Covid stimulus, so it is reasonable to think that there was some anticipatory nervousness.  The other expiration declines were relatively minor, so those could have almost as easily been random as the result of traders digesting the position squaring and rolling that accompanies a quarterly expiration.

That brings us to today.  In the course of writing this article, we have seen major indices open sharply lower, then rebound sufficiently to push NDX briefly into positive territory and SPX to nearly unchanged before turning south again.  The poor open was likely influenced by a continuation of yesterday’s selling, which picked up speed when ES futures traded below the 4650 level.  There were over 7,000 contracts set to expire on the open, so a dive below that level would have forced those who were short to re-hedge either by selling futures or by selling stock on the open.  Traders were clearly encouraged to see SPX bounce off the 50 day moving that has provided support on prior dips, but that enthusiasm appears to be fading. 

Looking toward the close, it behooves traders to follow expiring strikes that have large volumes and/or open interest.  As of now (noon Eastern), the SPY 460, QQQ 385, TSLA 950 and AAPL 170 and 172.5 strikes appear to be in play, and it is likely no coincidence that the underlying shares are currently gravitating towards them.  Of course, much can change before the close though.

Furthermore, market participants should avoid reading too much into this week’s activity.  SPX is less than 2% below its all-time closing high, which was reached just a week ago.  NDX is less than 5% below its own all-time high, which was reached on the last monthly expiration.  Declines of this minor magnitude seem quite meaningful to investors who have become accustomed to the relentless rise that we have seen since March 2020, but they are historically insignificant. 

Investors also should be wary of reading too much into moves that might occur over the next two weeks.  Volumes tend to wane around the end of the year, especially in holiday shortened weeks.  It is too early to say whether we will see institutions selling losers and adding to winners and whether we will see tax-related moves from individual investors.  Hang tight, manage your risks, and enjoy the holiday season.

[i] “Triple witching” became “quadruple witching” when single stock futures (SSF) began trading in the US in 2002.  They ceased trading in September 2020, at which point we reverted to triple witching.  SSF’s still trade on the TMX, so Canadians still have quad witching. 

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