Rate Cut Surprise Collides with Friday's Triple-Witching. What's Next for US Stocks?

However, this Friday, the market will face one of Wall Street's most dreaded events - the Triple Witching Day of September. Triple Witching Days typically occur on the third Friday of March, June, September, and December when stock options, index options, and index futures contracts all expire simultaneously. As traders close out or roll over their existing positions, market volatility and trading activity may increase, especially in the final hour of trading.

The most recent two Triple Witching Days occurred on March 15th and June 21st, with the S&P 500 falling by 0.65% and 0.16% respectively. According to derivatives analysis firm Asym 500, an estimated $5.1 trillion worth of index, stock, and ETF options will expire on Friday in September this year. Furthermore, the options expiration coincides with the rebalancing of benchmark indices like the S&P 500, leading to active trading around these positions, typically resulting in the highest daily trading volumes of the year. Investors are eagerly watching to see if the soaring enthusiasm for rate cuts can withstand the impact of Triple Witching Day, and whether the market will continue its upward trend or face setbacks.

Matt Thompson, a co-portfolio manager at Little Harbor Advisors, stated,“Triple-witching will likely inject more volatility into the market — we just don’t know which direction; Whatever the market’s opinion is about the Fed cutting rates will be exacerbated by a large options expiration on Friday.”

Historically, the U.S. stock market has seen some seasonal weakness on the Triple Witching Day in September. Since 1990, the S&P 500 has averaged a 1.1% decline one week after the September options expiry, with approximately 80% of years experiencing a downturn during this period over the past 34 years.Besides the market disturbance caused by the concentration of derivative expirations, traders returning to the market after the summer lull to readjust their portfolios, mutual funds selling off losing stocks at the end of the quarter and engaging in year-end tax-loss harvesting, households selling stocks to pay for education expenses, and the increasing complexity of the macroeconomic environment may also offer some additional explanations for the September softness.

However, the Federal Reserve's generous 50 basis point rate cut and supportive economic data for a soft landing have lifted market sentiment for this Triple Witching Day on Friday. Additionally, the Bank of Japan kept interest rates unchanged on Friday as expected, with BOJ Governor Kazuo Ueda adopting a cautious tone at the press conference, temporarily easing concerns among traders worried about hawkish moves from the Bank of Japan exacerbating the turmoil in the U.S. stock market.

While most long-term investors who buy and hold stocks do not need to be overly concerned, as such trading and heightened volatility may be short-lived, there are still some common investment strategies worth considering.

● Momentum trading and scalping: High-frequency traders with a higher risk tolerance could capture strong upward or downward momentum targets on Triple Witching Days and establish positions quickly to profit from short-term gains.

● Focus on top gaps and potential reversals: On Triple Witching Days, the gap between the previous day's closing price and the opening price may be more extreme, presenting trading opportunities. Moreover, the surge in volatility may quickly push some stocks into overbought or oversold territory, potentially leading to reversal opportunities.

● Trading market volatility: If a security's IV Rank and IV Percentile are low and investors anticipate increased future volatility, constructing a Straddle or Strangle strategy can be beneficial. By holding both call and put options before the options expiry date, investors can take advantage of market volatility. Additionally, trading volatility around the VIX through options or related ETFs is another viable approach.

● For investors already holding derivative contracts, it is essential to closely monitor market liquidity before the Triple Witching Day expiry and proactively manage positions by either closing them out or rolling them to different expiry dates.