Witching Hour: CNBC Explains

Witching hour—though it may sound like a Halloween promotion at a local bar— describes three important time periods for investors and the markets.

So what are witching hours and how do they impact investments? CNBC explains.

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What are witching hours?

Witching hours occur when financial contracts—specifically options and futures—end on the third Friday of a month.

The time periods—double, triple, quadruple—reflect the number of contracts that expire.

Traditionally, all contracts expire in the same hour—thus the name witching hour—usually the last hour of trading.

However, some contracts for all three time periods can expire at the beginning of a trading day as well.

What are options and futures?

Futures and options are the contracts that expire on witching hours. Futures are contracts obligating the buyer to purchase an underlying asset (or the seller to sell an asset), such as a commodity like corn, or a financial instrument like a stock, at a predetermined future date and price.

Options give investors the right, but not the obligation, to buy or sell an underlying asset at a set price on or before a given date. Options contracts are available on most of stocks, commodities, currencies, and other assets. You can even trade options on futures contracts.

These futures and options contracts fall into four broad categories: market index options, market index futures, stock options and stock futures.

What is the effect of witching hours on the markets?

Witching hours are used by traders to try to profit from the volatility in the underlying stocks or commodities.

Average S&P Volatility Index (VIX) for March '10 -'15: Measures expected stock market volatility for the next 30 days

Average Daily High Avg. 30 days prior Quadruple Witching
19.34 20.23

With all the activity of the contracts ending—most especially with triple and quadruple witching—and the reshuffling of market holding, the effect is usually a dramatic increase in trading volume, or the number of shares bought and sold.

Also of note: the value of future options—ones that have yet to expire—may be slightly higher than usual on the Thursday prior to quadruple witching and on quadruple witching Friday itself, due to the increased amount of trading.

What is double witching?

Double witching is the expiration of two related types of options and futures mentioned above. For example, it can be a stock option contract and stock future contract that both expire at the same time, or it can be a market index option and market index future that do the same.

Double witching happens eight times a year and occurs on the third Friday of the month—except in March, June, September, and December.

What is triple witching?

Triple witching is the expiration of stock options, stock futures, and an index option or index futures contract at the same time. The triple expiration happens four times a year on the third Friday of the month in March, June, September, and December—the months when double witching does not occur.

What is quadruple witching?

Quadruple witching happens when three related classes of options and futures contracts expire, along with the individual stock futures options.

Like triple witching, quadruple witching is the ending of contracts on the third Friday of every March, June, September, and December.

Quadruple witching is a relative newcomer, as it started after 2001. That's when single stock futures were introduced to traders.

What happens on a quadruple witching hour day?

On the day of a quadruple witching, many investors attempt to end their futures and options positions before the contracts expire. This activity often includes repurchasing contracts and/or closing out market positions.

Quadruple witching days are usually accompanied by considerable volatility in stock and derivative prices, as well as increased trading volume. Knowing that this is a volatile time, investors can anticipate and plan for the potential effects.

For example, on the quadruple witching days in 2014, the average trading volume was 5.2 billion on the S&P 500—compared to a 3.37 billion daily average for the period of March 20, 2014 to March 19, 2015.

According to a post by Jeff Hirsch, who blogs at Stock Traders Almanac, March's option expiration week performance "has a clearly bullish bias," with DJIA and S&P 500 reporting weekly gains in nearly twice the number of weeks as declines. However, the week after tends to be bearish for DJIA and S&P 500 with declines outnumbering advances.

—CNBC's Anita Balakrishnan contributed to this report