How Options Triple Witching Can Affect Stock Prices
The Dynamic Wealth Report
June 18, 2008
Are You Trading Stocks This Week?
by Brian T Mikes, Managing Editor
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?”
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“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.
• Corn ($7.66 per bushel)
Corn has been front and center on the world stage this week. The
flooding in the Midwest is damaging the crop and driving prices higher.
Initial estimates put crop losses at close to 3 million acres.
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