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Why Expiration Matters

Folks, today is quadruple expiration, the day where contracts for stock futures, index futures and options expire. I’ve been talking all week on the show about how, in addition to what’s happening in Europe, this expiration phenomenon also has an impact. So, why is it important?

There are literally hundreds of billions of dollars sitting in synthetic positions that replicate the performance of an index. For our purposes here, let’s say it’s the S&P. If you have a 401K or an IRA that’s set up so your money goes straight into an S&P fund, that fund manager isn’t going out and buying the actual stocks. He’s replicating the ownership of those stocks using a derivative strategy and trading around that.

How does he do it? He buys futures contracts, then uses the rest of the money for an options position overlaying that contract.

Why does he do it? It’s how he makes his money. The position he puts on has to replicate the S&P 500. Any additional yield is revenue.

Today, that entire world rolls over. This is the best and easiest time for people who have large positions to get in and out of the market. And when big positions like this move, it leaves large footprints that are felt indirectly throughout the marketplace.

The action in the last few days has led me to believe that there has been a shortage of inventory—market makers on the short side were oversold and found themselves in a desperate spot. Their buying is part of what’s been behind this week’s rally, but don’t get too excited quite yet. I’ll feel much better if it continues through today: that will let me know the market is rallying fundamentally and not because of expiration.


As he does each and every week, Howard Marella, president of Index Futures Group, stopped by the studio today for Futures Friday. He pointed out something I hadn’t noticed and I think is very important to keep an eye on. Previously, the correlation had been dollar down, gold up, Eurocurrency up. But we’ve been seeing hints of a decoupling taking place, and the new correlation has been Euro down, gold up, dollar up. And this morning, equities opened in the green with the Euro down. Very interesting.
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