Quad Witching15 Sep 2021 09:31
In 2020 during the 4 Quad witching days most stock were down each time.
However in 2018 and 2019 most stocks were up during this time.
It’s a heads or tails depending on lots of things…..
Let’s put yourself in the shoes of a trader that is forced to make a decision on a quad witching day.
You’re holding 1,000 shares of a relatively illiquid stock XYZ long, and you’ve written 10 calls against the position, creating a buy-write (which is identical in P&L to a short put). The calls expire on June 18th, the next quad witching event.
June 18th comes around, and your calls are going to expire worthless. You meant to roll them to the next expiration a few weeks back, but you forgot. So now it’s expiration day, and you don’t know what to do.
You decide that you want to roll the calls over to the next quarterly expiration, so you buy back your calls and write another 10 in the next expiration.
It seems simple, but your activity is just a microcosm of all the potential trading going on that day.
You and many others are in the same position, closing, rolling, exercising, or letting your derivatives expire on that day. Not only is this an unusually high level of volume for the derivatives markets, but the market makers play a role here.
Remember how we mentioned that XYZ is illiquid? Well, chances are, there was a market maker on the other side of your trade.
And that market maker is trading quantitatively, according to their options pricing model. So they have no interest in taking on your directional risk.
As a result, they have to delta-hedge the position by buying a proportional amount of stock. If the delta on your calls is 0.10, they have to buy 10 shares of stock per call to hedge the position.
This type of market maker hedging happens every single day and usually is no problem.
But when that hedging becomes a much larger than usual portion of the daily volume, we can see some pretty weird price action, leading to traders giving this day its ominous name of quadruple witching.
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