Trading during options expiration and futures contract rolling weeks can be particularly challenging, especially in the indices and popular stocks among options traders.
The complexity of these periods is amplified by the interplay of various factors, including theta and delta decay, and the often unpredictable outcomes of position rolling.
The Nature of Futures Contracts and Rollovers
Futures contracts, unlike stocks or spot markets, have a set expiration date. The rollover process involves closing out positions in expiring futures contracts and opening new ones in newly formed contracts. This process can significantly impact market volatility, prices, and volume.
Physically settled futures contracts, more common in non-financial markets like commodities, require the delivery of the underlying asset upon expiration, adding another layer of complexity.
Cash-settled futures, more prevalent in financial markets, settle for cash after expiration, affecting account balances of traders depending on their positions.
In essence, you have large players that need to roll large positions and they don't care about what a chart says or what the fundamental or macro picture may be. They simply have to move positions and that may distort dynamics which may otherwise have a reasonably strong success rate.
Roll Dates and Market Volatility
The period around roll dates, usually a few days before the actual expiration date, is marked by heightened volatility. Trading volumes during these periods are often split between expiring and new contracts, leading to large price swings and gaps.
Because participation is divided between two contracts, that can create situations where indicators do not work the way we may expect, where we have less than ideal fills, or where price behavior is bizarre within the context of the outcomes we may otherwise expect.
Witching days, when multiple asset classes or derivatives expire simultaneously, further exacerbate this volatility. These include double, triple, and quadruple witching, each bringing its own set of challenges and erratic market behavior.
Options Expiration and Stock Market Dynamics
Options expiration in the U.S. typically occurs on the third Friday of every month.
As the expiration date approaches, options positioning and contract rolling can have a direct and measurable effect on stock prices, especially on the last trading day.
The concept of pin risk, where traders face the obligation of taking delivery of shares if they have issued options, adds to the volatility as traders hedge their positions.
Impact of Theta Decay
Theta represents the time decay of an option's value as it nears expiration, especially if it remains out-of-the-money. This decay can work in favor of traders selling options to collect premium income, as the underlying security has fewer opportunities to challenge the strike price. It also means that when there is heavy skew to one side, that the underlying may move the opposite way.
For example, if there is heavy put skew in the S&P 500 going into OpEx week, that may provide a strong bid for the index, particularly in the first and last hours of the trading day.
Closing Thoughts
Given the complexities and uncertainties during options expiration and futures contract rolling weeks, traders need to exercise caution. These periods are characterized by unpredictable market behaviors driven more by flows and less by technical analysis.
While some of these flows can be quantified by retail traders, many positions and their changes remain obscure, making it challenging to fully appreciate the market dynamics as they are playing out in real-time.
It can be prudent to adopt a more conservative approach during these periods. This might involve trading different products, or using the time to learn and strategize instead of trading.
In a nutshell, there's no shame in not trading, but if you do, please be careful. If you don't, take the time to do something else that helps you trade during periods where your success rate may be higher.
If you have any questions, let me know!