Should Dow Investors Fear the Quadruple Witching Hour?

Four times a year, other markets have a big impact on the Dow Jones Industrials. Find out more about it.

Jun 20, 2014 at 1:30PM
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Today is looking an unremarkable day for the stock market, even as major U.S. indexes push their all-time highs. As of 1:15 p.m. EDT, the Dow Jones Industrial Average (DJINDICES:^DJI) was up just 24 points. One factor that many Dow investors are watching closely is the so-called "quadruple witching hour," which is set to occur this afternoon. Yet should you really be concerned with this occult piece of market jargon? Let's take a closer look at what quadruple witching is and what it means for your investing.

Witch

Source: Wikimedia Commons.

A derivative concept
The idea of the witching hour comes not from the Dow Jones Industrials or the broader stock market, but rather from various types of derivatives. In particular, you can buy options on a wide variety of individual stocks as well as stock market indexes, and those options are typically available for every calendar month. These options are usually set to expire on the third Friday of the month, although more recent innovations in the options market have introduced expirations on different weeks. Nevertheless, these traditional options are the most commonly traded.

In addition to options, futures contracts track the major stock market indexes, including the Dow Jones Industrials and the S&P 500 (SNPINDEX:^GSPC). The introduction of single-stock futures added a fourth set of derivatives to consider. Four times a year -- on the third Friday of March, June, September, and December -- all four of these options and futures contracts expire at the same time.

Does witching matter anymore?
The concern that many Dow investors have about quadruple witching is that as short-term traders rush to consolidate their derivatives positions before they expire, the resulting turbulence can carry over into the stock market. Derivatives traders often hedge their positions with actual stock holdings, and so when they close derivatives positions, they also close those hedges with purchases or sales of certain stocks.

But when you look at recent quadruple-witching days, there hasn't been the same level of volatility for which the event was once famous. In March, for instance, the Dow lost a mere 30 points on its quadruple witching day. December's quadruple witching resulted in a gain of 42 points. Similarly, the year-ago event in June saw a rise of 41 points.

Of course, there have been instances of big moves on quadruple witching day. Last September, the Dow dropped 185 points when futures and options expired. But overall, the recent trend has been toward less volatility, and although you can still see volume spikes on expiration days, they aren't as extreme as they once were.

Even when short-term traders create momentary disruptions to the Dow, they don't have a lasting impact on the long-term movements that stocks make based on fundamental factors. As a result, Dow Jones Industrials investors who focus on the long run don't need to fear quadruple witching days at all.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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