Sluggish Market Volume Set to Spike for Quadruple Witching

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(Bloomberg) — Equity traders frustrated by recent sleepy volumes are getting a big liquidity boost.

Stock transactions spiked Friday amid a quarterly event known as quadruple witching, when options and futures on indexes and equities expire. During the first 15 minutes of trading, volume on S&P 500 stocks more than doubled the average for that time of day over the past 30 sessions as the benchmark slipped 0.5%.

The event usually brings single-day volumes that rank among the highest of the year — welcome news for investors who need to shuffle big holdings. There’s a lot to shuffle. The broad rotation away from stocks that benefited from the pandemic lockdowns to ones that should thrive as the economy bounces back means that exchange-traded funds and quant traders may be forced to dramatically switch positions, in what could become the most turbulent rebalance ever.

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Quadruple witching arrived in the wake of tepid trading, with an average 12 billion shares changing hands in the past four days, the slowest since December. The light volume reflected investor hesitation to place big bets around Wednesday’s Federal Reserve Open Market Committee’s policy announcement and came as rising yields are wreaking havoc on risky bets, from unprofitable technology firms to newly minted stocks.

Sentiment is “neurotic but net bullish, especially after such an important FOMC meeting,” said Michael Purves, chief executive officer at Tallbacken Capital Advisors. “Sometimes it takes the market a bit of time to get strong conviction one way or the other.”

Investors started to reassess equity risks as 10-year Treasury yields marched above 1.7%, the highest in more than a year. While the S&P 500 reached an all-time high this month, boosted by economically-sensitive companies like banks, the benchmark has yet to break the 4,000 mark.

Partly driven by a retail-driven rush for call contracts to chase winners, the size of option expiration this time is by some measure unprecedented. The notional value of single-stock options that are set to expire Friday totals $655 billion, the largest non-January expiry and the third-largest on record, according to data compiled by Goldman Sachs Group Inc.

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As usual, quadruple witching coincides with a rebalancing of benchmarks such as the S&P 500 Index, another event that typically sparks trading. According to an estimate from Howard Silverblatt, senior index analyst at S&P 500, the rebalance in the index alone could force $30 billion of stock trades.

While trading activity rose Friday, the impact of quadruple witching on the market’s overall direction is not easy to predict. If volume is any guide, its near-term fate is nothing more than a coin toss.

During the past 25 years, stock volume during option expiration weeks tended to be 5% higher than the 50-day average, Sundial Capital Research’s Jason Goepfert found. But this time, trading is running about 13% below the average. Similar quiet weeks ahead of option expiration have resulted in the S&P 500 rising 52% of the time in the following week, his study shows.

Another way to examine the event is through the lens of options dealers, who typically need to hedge their positions by buying or selling underlying stocks. Their holdings are often scrutinized, since “long gamma” indicates they’re pushing against the prevailing market trend while “short gamma” points to a tendency to go with it.

Heading into Friday, dealers held $4.9 billion worth of long gamma exposure for the S&P 500 to stay at 3,950, a level that acts as a “rubber-band” for the market, according to Charlie McElligott, a cross-asset strategist at Nomura Securities. With a significant amount of hedging positions trimmed after Friday, it could set the stage for the index to move in a wider price range, he says.

McElligott says investors should take advantage of any pullback to add positions, especially as rising yields keep hammering the market. The way he sees it, the economic reopening will gather pace in coming months, helping propel the S&P 500 to another level where dealers appear to have big exposure: 4,000.

That “feels like a ‘round number’ inevitability,” McElligott wrote in a note. “So I’ll keep pounding the table on scooping equities’ upside.”

(Updates for early Friday volume in second paragraph, chart)

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