Expiration of options and futures on stocks and indexes—known as quadruple witching—promises even more-hectic trading, assuming that’s possible
March 19, 2020 5:30 am ET
Friday is shaping up as potentially one of the most volatile trading days in years, as scheduled changes in futures, options and other derivatives markets threaten to add to a frenzied trading month that has already had some of the biggest daily stock-index swings ever.
The S&P 500 has risen or fallen at least 4% in eight straight sessions, the longest streak in history, according to Dow Jones Market Data. The Cboe Volatility Index, the Wall Street fear gauge known as the VIX, hit its highest level in history this week.
Traders are bracing in part because of so-called quadruple witching, the Friday near the end of each calendar quarter on which options and futures on both indexes and stocks expire simultaneously. Options contracts outstanding tied to the S&P 500 Index hit a record this week. More than $1.5 trillion worth of S&P 500 options were slated to expire Friday, about a third of the contracts outstanding, according to Trade Alert data.
“Right now I would say buckle in,” said Steve Sosnick, chief strategist at Interactive Brokers, on the next few trading sessions. “Those moves in both directions can really be exacerbated.”
Trading volumes, which have already been at near-record levels in recent weeks, tend to pick up on quadruple-witching days. On the last such day, Dec. 20, 2019, about 11.8 billion shares changed hands in the U.S. stock market, compared with an average of about 7 billion shares a day last year, according to Rosenblatt Securities.
Many big traders will likely be closely following overnight moves in the markets from Thursday to Friday because they hold options on the S&P 500 that expire Friday morning, said Russell Rhoads, head of research and consulting at EQDerivatives. Such overnight swings are unusual, but they have grown more common with the coronavirus pandemic. “The overnight risk is much greater than it has been in a long, long time,” Mr. Rhoads said.
The volatility is likely to exacerbate concerns about the market that have arisen during the crash of the past month. Within the U.S. stock market, liquidity—a term used to describe how easily buyers and sellers can transact with each other—has evaporated by many accounts.
The spread between the price buyers are willing to pay for a stock and the price sellers are willing to accept is the widest in at least the last eight years, according to Goldman Sachs. Meanwhile, a measure of liquidity for futures tracking the S&P 500 has fallen to the lowest level since 2006.
The result? Stocks, especially those with lower liquidity, including many smaller-capitalization companies, have been more susceptible to outsize swings—particularly to the downside. The Russell 2000 index of smaller stocks is down 41% this year, compared with a 30% decline in the Dow industrials and a 26% drop in the S&P 500.
A big swing in the markets overnight could quickly turn a profitable options trade into a money-losing one, so traders could seek to hedge their trades with futures on the S&P 500. But those futures are limited to 5% moves up or down overnight, and in the past two weeks they have repeatedly slammed into such “limit up” or “limit down” levels. An options trader seeking to hedge with S&P 500 futures when trapped at the limit-down level would be “in a really precarious position,” Mr. Rhoads said.
Extreme volatility in credit markets this week prompted traders to question whether the rebalancing of widely followed corporate bond derivative indexes will take place as scheduled Friday. IHS Markit, which operates the CDX and iTraxx indexes of credit-default swaps on investment-grade and high-yield bonds, said the removal of certain companies from the indexes and the addition of others will go forward as planned.
“Many firms currently have operational complexities based on COVID-19 workplace arrangements,” Markit said in a statement. “Despite this, the majority of market participants have confirmed their ability to facilitate the roll as scheduled.”
The CDX index for U.S. high-yield bonds was quoted at around 89 on Wednesday, down from 98 last week. The index is at its lowest level since the European debt crisis in 2011, according to data from Markit. Credit-default swaps are derivatives that enable traders to hedge against a default on a firm’s debt or to make a bet on the perceived likelihood of such a default, while the CDX is an index that reflects the price of those hedges on an index of large bond issuers.
The volatility in markets has become so extreme that Cboe has introduced new levels at which options tied to the VIX can be exercised.
In recent weeks, many traders have pointed to options hedging as a driver of greater volatility. Some options dealers have to sell stocks to hedge their bets as markets are falling and buy when markets are rising, potentially magnifying stock moves in both directions. If many options expire Friday and new positions aren’t established, some traders said that could help push volatility lower.
Adding to the uncertainty, traders around the country are struggling to adjust to new routines as many have started working from home during the coronavirus pandemic.
Cboe Global Markets Inc., which oversees trading for VIX and S&P 500 options, said last week that it would suspend open outcry trading as a “precautionary measure to prevent the potential spread of the novel coronavirus."
Though old-fashioned trading using hand signals and shouting has largely shifted to computers in recent years, Chicago-based Cboe’s VIX and S&P 500 options pits are usually bustling with activity. That is because institutional investors often prefer human traders to execute complex derivatives wagers. The shift to a solely electronic platform introduces fresh uncertainty.
A spokeswoman for Cboe said the exchange operator is “confident” that it will “continue to provide reliable markets.”
Still, many are bracing for turbulence.
“It could be an extra hairy quadruple witching,” said Henry Schwartz, founder of options data provider Trade Alert.
—Akane Otani, Alexander Osipovich and Matt Wirz contributed to this article.