How Options Triple Witching Can Affect Stock Prices

| June 18, 2008 | 0 Comments

Just the other day I received a phone call.  It was from a good friend of mine who was thinking about making a trade in his retirement account.  The idea was really interesting.

He’d done his research.

He talked about the macro-economic view which started him thinking. Then he talked about his industry research.  As he was looking at the industry he uncovered a particularly interesting company.  He researched their products and read about their management.  Then he reviewed the financials . . . which were solid.

He even looked at the company’s customers.  A few were big a few were small but they were all buying.  As you’d expect, operations were steady, and earnings were growing.

I couldn’t help but think that this was a great idea.

But then he went a step further.  Looking at the technical analysis he noticed a pattern setting up.  It was perfect.  The stock’s in a confirmed uptrend, continuing to set higher highs and higher lows.  It had pulled back recently on no news.  My guess would be profit taking.  Now it was trading near the low end of the range.

It was a perfect trade, a perfect time to buy.

But then I asked a question that stopped him in his tracks.  “When are you going to buy this stock?”

“This week!” he said with excitement in his voice.

“What about options expiration, this week is triple witching?”

Silence.

I had burst his bubble.  Options expiration comes every month.  It’s always on the third Friday, rain or shine.  In some months options expiration is more important than others.  Those option expiration days are known as triple witching.

I know you’re thinking to yourself . . . What’s triple witching?

Four times a year Stock Index Futures, Stock Index Options, and Stock Options all expire on the same day.  The traders have nicknamed this day “triple witching.”  It only happens four times a year – on the third Friday of March, June, September, and December.

So why care about triple witching . . . or any options expiration for that matter?

I can answer that in one word – volatility.  Believe it or not, the week of options expiration is often very volatile.  Why?  It’s when big institutional investors and hedge funds push around a stock price.  Often times they own a large number of put or call options.  These options only have value if a particular stock finishes the week “In the Money.”

So if they own puts they might push the stock lower.  With calls they might drive it higher.  Don’t believe me?  Just read my article on the end of quarter window dressing that goes on. . . It’s the same exact thing.

Now one important point.

This doesn’t happen to every stock.  The mega cap companies have too many shares outstanding to push around easily.  The small cap companies either don’t trade options, or the options aren’t liquid enough to establish a big position.

The mid cap companies with liquid options are perfect to push around. Just watch your midcap companies closely over the next few days.  Often times you’ll see them gravitate towards the closest option strike price.

Let me give you an example.

If a stock is trading at $62 the closest option strike prices will probably be $60 and $70.  Keep in mind that options strike prices vary depending on the security.  Some are available in $5 or $10 increments, others are available $1 apart.

So in our example, the stock is likely to trade down to $60 as that’s where the majority of the option trading is probably focused.  Now, I’d also argue that if the stock was trading at $68 I think it’s more likely to gravitate towards $70.

Unfortunately, this is far from a certainty.

But ask anyone who has been trading the markets for a few years and they’ll share stories of seeing similar events.  I try to avoid trading stocks during the week of options expiration – especially during triple witching.  You don’t want to be buying at a time when a multi-billion dollar fund wants a stock to go down.

Just a friendly reminder, this week is options expiration . . . . and triple witching no less.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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