foxex: The Big Witch

Chart Advisor | Focus on the Price

Tuesday, September 22, 2020 Headlines

1. Stock markets show increasing sensitivity to quadruple witching days
2. Returns: annual is better, monthly is worse
3. One-week returns are comparatively poor

Market Moves

Stocks have entered a mild correction after selling off yesterday and the S&P 500 (SPX) is up 1.05%. Although today it closed higher, the markets seem to be on a downtrend. One simple indication lets traders know to expect such moves around this time of year. The third Friday in September is the third quadruple witching day of the year, only six weeks before Halloween.

Historical data suggests this day should probably be nicknamed the Big Witch, since September tends to be seasonally among the poorest times of the year for investing performance. Consider the statistics represented in the charts below.

The average annual return for any given one-year period since 1928 (the first year for which data on the S&P 500 index is kept) is just under 7.7%. This is the average performance based on any given starting day of the year and ending on that same day next year. If you look at the same measure, but only for days after 1987, returns seem to improve. This point in time is often recognized by industry insiders when options trading began to grow significantly in popularity.

However, single-stock futures were not consistently traded until the year 2001. Single-stock futures are the fourth component that makes up the definition of the quadruple witching day, so it wasn't until that year that the third Friday at the end of a quarter should become significantly different from any other expiration day.

As it turns out, the returns from buying on the close of a quadruple witching day and holding for one year after that are significantly lower when measured for years after 2000. The data becomes even more surprising as time periods compress, suggesting that the impact of this day in the markets is real and should not be ignored.

Returns: Annual is Better, Monthly is Worse

Consider the statistics for one-month returns after a quadruple-witching day (shown below). These stats measure the average move 20 trading days (four calendar weeks) after the third Friday before each quarter's end (March, June, September and December). The returns are diminished as options became more popular after 1987, but even more diminished as single-stock futures began to be added into regular activity. It appears that buying at the close of a quadruple witching day and simply holding on for one month is a particularly poor strategy. But perhaps most of this is attributable to the first five days directly after that day.

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One-Week Returns are Comparatively Poor

The statistics below are downright stunning. In the 5-day period after a quadruple witching day, the performance for the S&P 500 index is nearly one-third of a percent worse than it has been historically in any other time frame. This tendency to sell off after that particular type of expiration day is notable because investors may not naturally anticipate this move. It likely happens because so many investors are hedged with options and futures contracts right up to that point, and until that time these large investors have a lot of incentive to keep markets from falling lower.

Once these hedges expire, traders need to move them to later-dated contracts. This would imply that there is less risk to commercial hedgers after that date has passed, because they can wait for a longer period before they have to worry about the impact of price fluctuations.

Since larger price fluctuations can be more easily tolerated, it therefore shows that less effort and fewer trades will be made to try to stabilize the index during the week that follows a quadruple witching day. As such, it may be worthwhile for chart watchers to keep this dynamic in mind during those times of the year when this day occurs.

The Bottom Line

Quadruple witching days may lead to more selling than usual in the week that follows. Considering that the previous three weeks have sold off already, a fourth week would only add to the correction underway. Today's action likely reflects this phenomenon.

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