Quadruple Witching Got A Downgrade

Today is a quarterly expiration. It’s kind of a big deal, not only because it happens just four times a year, but because the converging expiries of stock index futures, stock index options, and individual equity options can often bring volume and volatility. The sharper-eyed among you may be thinking “wait, those are only three items – I thought it was quadruple witching ”. Times change and quadruple witching got downgraded to triple witching a few months ago. Few noticed or understood why.

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The reason for the reversion was that single stock futures (SSFs) had their final expiry last September when the last contracts expired and OneChicago shut its doors. I didn’t really think about the change to expiration terminology when the exchange closed six months ago. I was one of the few who traded the product, so I should have noticed – though my role was a backup to a colleague who was the primary market maker in SSFs. To paraphrase T.S. Eliot, SSFs went out not with a bang, but with a whimper. 

In 2002, triple witching became quadruple witching with the advent of single stock futures. Two competing exchanges, NQLX and OneChicago, arose to trade the newly approved product. Their expiration cycles matched those of individual equity options, so the terminology changed when they were added to the roster of expiring financial instruments. There were high hopes for the product when it was launched, which is why major exchanges like Nasdaq, CBOE, and CME jumped into the fray. (Disclosure – Interactive Brokers was an investor in OneChicago along with CBOE and CME.). The commercial logic existed but never fully materialized. The explanation bears analysis.

The advantages of single stock futures are evident if there are impediments to short-selling or if interest rates are high. The former condition has never been the case in the US, though short-selling restrictions upon individual investors led to a robust SSF market in Spain for a time. The latter condition was the rationale for SSFs in the US.SSFs had a favorable margin treatment, with lower initial and maintenance margins than ordinary shares. If interest rates were in the high single digits or more, that differential would have allowed investors to hold SSFs cheaply than holding stocks on margin. The problem is that rates mostly fell from the time when the product was conceived until when it was approved and launched. Fed Funds were around 5% during the late ‘90s through 2001 but had fallen to about 2% by the time SSFs hit the market. That made the product a tough sell, especially when there were two exchanges with non-fungible contracts. Eventually, NQLX folded. Although there was a brief return to 5% rates in the 2006-07 period, the ensuing financial crisis and sharp reduction in interest rates prevented the product from getting traction. Since then, rates have been near zero except for a brief rise in 2019.

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