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Friday's Quad Witching Explained

|Includes: DIA, SDS, SPXU, SPDR S&P 500 Trust ETF (SPY), SPY

Unknown-Little-old-ladies-dressed-as-witches-drinking-tea-53720What is Quad Witching?

Generally there's a great deal of confusion concerning the term "quad witching" and what this day may constitute in financial markets. As a result, we would like to take this Quad Witching Friday, March 19, 2010, and demystify the phenomenon once and for all.

"Witching" signifies the expiration of an entire group of derivative or futures financial vehicles.  While usually void of economic indicators, the "Quad Witching" Friday is assuredly more volatile, as financial markets antiquate the time value of derivative contracts leading into expiration.

"Quad Witching" is a term used to describe the expiration of Stock Index Futures, Stock Index Options, Individual Stock Futures, and Individual Stock Options contracts.

Triple and Quadruple Witching days are generally synonymous with high trading volume and volatility, due to contracts expiring and the calling in of contract obligations to be honored. Many derivatives hold certain values based on expectations concerning the value of the underlying security and the length of time until expiration. This causes many losing positions to be covered in a hurry when the strategy goes bust and large numbers of shares to trade hands as prices swing through wide ranges. 

More complicated factors such as Delta, a derivative of options contracts, representing the time until expiration, are also traded and constitute additional positions which must be closed on a Quad Witching day.

Alas, it becomes clear why the talking heads on business television and traders on the floor expect anything other than "business as usual" on a "witching" day.

Disclosure: Disclosure: No Positions