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Beware the Witches of September!

Written By Briton Ryle

Posted September 19, 2014

It’s not quite Halloween yet, but the witches are already revving up their brooms, clad in their finest rags, and cackling their merry song of mischief. Investors beware – the Witches of September will be flying this afternoon at a stock exchange near you.Three Witches

Luckily, the witches make their rounds creating havoc on the markets just once a month, on the third Friday of the month, known as “Freaky Friday”. There are at least two witchy sisters who take to the skies each month – one who molests stock markets, while the other sinister sister stalks the futures markets.

But every quarter on the last month of the quarter, the two wacky witches are joined by a third twisted sister for a night on the town that makes even the wildest cougars look tame. The evil triplets are at their worst when three threes all line-up together – the third Friday of the third month of the third quarter. And today is that day!

If three is the perfect number, then today will be met with perfect madness and perfect mayhem on this third and most ominous Triple Witching of the year.

Which Witch is Which?

Just who are these witches, and why do they spook the markets with such regularity?

It all has to do with the expiration of certain contracts, during which many traders feel like expiring themselves. The madness on the trading floor on those days can take your breath away!

But not all contracts are involved; only those contracts that expire on the third Friday of the month, which include three main classes:

• Stock options and stock futures (companies and exchange-traded funds – every month),

• Index options (S&P 500, Dow Jones Industrial Average, etc – every month),

• Index futures (S&P 500, Dow Jones Industrial Average, etc – last month of every quarter; March, June, September and December).

Commodity futures and options are not part of the witches’ rampage, however, as they expire on other days. Many commodity futures expire on the third-to-last trading day of the contract month, while many commodity options terminate on the fourth-to-last trading day of the month prior to the contract month, with more varieties from one commodity to another.

Some of these commodity expiration days are something to marvel at. Take options on corn futures, as an instance, which expire on “the last Friday which precedes by at least two business days the last business day of the calendar month preceding such option’s named expiry month,” notes CME Group. Wow! I can see why the witches don’t bother with commodity markets. They’re messed up already!

Back to our witches, then, every month has at least two of the sinister sisters take to their brooms to spook the markets, which months are known as “double witching”. Yet on the last month of every quarter – March, June, September, December – all three witches come out to play, which months are known as “triple witching”.

With the advent of single stock futures a few years back, a fourth witch has joined the original three, which is why you’ll sometimes hear of “quadruple witching”. But since stock futures expire monthly like stock options, they are both generally lumped together, so that “triple witching” still applies.

Witching Hour is No Happy Hour

What makes these expiration-filled witching days so full of mayhem is the increased volatility, especially during the last hour of the day, the infamous “witching hour”. For traders on the trading floor and institutions at their terminals, this last hour of the work week is not a fun one.

“Witching hour is typically controlled by large professional traders, program traders and large institutional traders, and can be characterized by higher-than-average volatility,” describes Investopedia. “The last hour of these Fridays can be very volatile as positions are adjusted or closed out in anticipation of expiration.”

Generally what happens on these Freaky Fridays is that investment funds and institutional traders will sift through their futures and options, closing some positions outright and/or rolling other positions forward into future contracts. Rolling positions, of course, involves closing one contract and opening another, which effectively doubles the normal volume.

Leaving Chaos in Their Wake

Yet the witches’ rampage this month could be more devastating than normal. As the Stock Trader’s Alamanac warns, “September Triple-Witching Week can be dangerous”, while the “week after is pitiful”.

“We have analyzed what the market does prior, during, and following Triple Witching expirations in search of consistent trading patterns,” the Almanac informs. Here’s what they found:

• Triple witchings have become more bullish since 1990, while the week following a triple witching has become more bearish,

• Since 2000, the week after triple witching has been up only 17 times out of 48 – eight of them being the last week of December, six of them being the last week of March, and only three of them being the last week of September, while June had zero up weeks after triple witching,

• Since 1991, a down triple witching day was followed by a down week 21 out of 29 times,

• The weeks following June and September triple witchings are generally “horrendous”, as compared to the weeks following December and March triple witchings.

So what can we expect this time around?

After the Trick Comes the Treat

While these chaotic witching hours can be hair raising and frantic for the traders doing all the work, “if you are a long-term investor, triple witching will have a minimal impact on you,” Investopedia eases our minds.

In fact, for long-term investors, after these witchy vixens have had their fill of tricks and mischief, they will often leave behind some treats as they fly off. At the end of a particularly intense witching event – maybe a couple of weeks after – investors can find some really great bargains that have been pummelled in the frenzy.

This is what makes the third triple-witching of the year in September stand-out among the others. Since it comes at the end of the summertime lull and just before the push upward into year’s-end, we can expect to see some pretty wild swings, likely with more downs than ups.

But don’t be swayed by the commotion and turmoil, as there should be some nice buying opportunities in the aftermath.

Joseph Cafariello