On Friday, markets reacted to a slew of different headlines that battered our ears from all sides.
Fed Chair Jerome Powell issued a carefully worded statement through an interview this morning, while one of his predecessors would distract the audience with random tidbits about the shoe manufacturing industry during the Great Depression (I’m not a good enough fiction writer to make that up). He also said the financial system was stable.
Treasury Secretary Janet Yellen – picking investors’ pockets while no one was looking – then announced that the system wasn’t stable. She noted that there will likely be more forced mergers among banks in the future.
Midjourney: “1990s nintendo graphics, janet yellen and jerome powell in a boxing match”
Finally, investors continued speculating on momentum stocks like Nvidia (NVDA), while Congress cut off debt ceiling talks.
All this happened against the backdrop of Options Expiration.
Let’s cut through all this noise and discuss the one constant in this market. Every third Friday of the month, the options cycle leads us to a big expiration date. Let’s discuss how these expiration dates work.
Understanding the Options Cycle
The Chicago Board Options Exchange (CBOE) was launched in 1973. It originally centered on allowing options for a specific underlying asset like stocks, to expire on a quarterly basis. This quarterly basis referred to the schedule on which options contracts would expire.
Options traders know that these contracts have a predetermined lifecycle. A call option gives a buyer the right, but not the obligation, to purchase a stock (or other asset) at a predetermined strike price – on or before an expiration date.
CBOE’s expiration cycle allows for buyers and sellers to organize the trading of these contracts. Now, historically, we would look at the quarterly cycle of options that expired at the end of each calendar quarter.
These options contracts (known as “serial options”) are common for stocks that have more volume or are tied to the underlying indices like the S&P 500 or Russell 2000.
The monthly cycle is different. And in the case of today, we had options expire on this cycle during the third Friday of May. Each month, monthly options expire during the third Friday of the month.
Recently, we’ve seen an explosion of options on a weekly (and sometimes daily basis for index funds). But the Third Friday is always a critical day for the equity options market.
Now that we’re past Third Friday, we now turn our attention to the third Friday in June. This is historically one of the most important trading days of the year. It’s known as “Quad Witching.”
What is Quad Witching?
Quad Witching occurs four times per year: On the third Friday of March, June, September and December.
This is the day that not only equity options expire, but so too do options contracts linked to single stock futures, stock index options, and stock index futures.
These days typically see trillions of dollars in expiration, which can fuel massive levels of volatility and volume in the markets.
This day – approaching in four weeks – is critical because so many traders across the globe start to shift their positions on these contracts, engaging in hedging, building their positions, or selling ahead of expected price movements. Once again, this can produce dramatic fluctuations in price in all assets.
There’s one really important thing to note.
Many people believe that quad witching really impacts stocks.
That’s not true… in comparison to the options (or derivatives markets). Typically, we see larger moves in options activity.
Naturally, large moves in options demand and price movement can impact the underlying price (such as the Gamma Squeeze we saw on Nvidia Thursday).
But remember, Quad Witching is really about contract trading.
We’re now one month away from the Quad Witching date.
This is why it’s more important than ever to learn more about how options work, and how they can provide additional income to your portfolio.
To your wealth,
Garrett Baldwin
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
Market Momentum is GREEN
Momentum has been green for a whopping six hours total, and we’re seeing some weakness persist in the S&P 500. I will continue to monitor this situation. We will hold our hedge over at Tactical Wealth Investor through the weekend. Looking ahead, there are many threatening factors in this market – particularly the ongoing threat of a debt default and persistent consumer weakness across the economy. Stay cautious.
