Markets

Stock Markets Head Lower -- Is "Quadruple Witching" to Blame?

The stock market has started to show signs of rising concern in September, with investors no longer seeing major benchmarks moving straight up. Instead, worries about the COVID-19 pandemic, the November presidential election, and various geopolitical issues around the world are weighing on sentiment. Just after 11:15 a.m. EDT, the Dow Jones Industrial Average (DJINDICES: ^DJI) was down 85 points to 27,817. The S&P 500 (SNPINDEX: ^GSPC) fell 22 points to 3,335, and the Nasdaq Composite (NASDAQINDEX: ^IXIC) lost 94 points to 10,816.

There's a lot of jargon on Wall Street, and it's easy for investors to get confused. Today, for instance, market participants are referring to something called "quadruple witching" as having a possible impact on stocks. But few people bother to explain exactly what they're talking about when they mention quadruple witching. Read on to learn what quadruple witching is and whether you should be concerned.

Person wearing pointed witch's hat holding book, with skull and other creepy things nearby.

Image source: Getty Images.

The market beyond stocks

Many investors never bother to go beyond investing in stocks or funds. That's perfectly fine, and you can be successful doing that.

However, there's a whole different world of other investments out there. Specifically, there are several types of derivative investments that large institutional investors regularly use. Among them are the following:

  • Stock index futures contracts, which allow institutions to get substantial exposure to the stock market with relatively small up-front investment.
  • Options on stock indexes, which let investors take positions based on their beliefs about the future direction and timing of stock market moves.
  • Options on individual stocks, which provide targeted exposure to specific companies and movements in their share prices.
  • Single stock futures contracts, which give investors the ability to control large blocks of stock without having the full amount of cash to buy shares outright.

You can hold a stock forever; it never expires. That's not the case with these derivative investments. Each of the four categories above has specific expiration dates associated with them. If you don't take action or if specific conditions aren't met, then the derivative investment becomes worthless after its expiration date.

The witching hour

However, these products have different cycles they follow with their expiration dates. You can find stock options with expiration dates just about every week. Futures contracts are often available on a monthly basis, but some products only have expirations spaced out quarterly.

Four times a year, all four of the derivative investments above line up their expirations. That happens on the third Fridays of March, June, September, and December.

What this means for regular investors is that while they're going about their usual business today, the institutions that trade in derivatives have a lot going on. They'll need to take steps to close out their positions or push them forward a few more months. Their actions often ripple into the broader stock market, causing volatility.

Long-term investors don't need to worry about what's happening with quadruple witching. It doesn't have anything to do with the fundamentals of the companies in which you're invested. Quadruple witching only represents one more aspect of the stock market that's tailored toward a very specific type of trading.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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