Quadruple-Witching, S&P Reclassification – Ingredients for Turbulent Closing Hour

The major U.S. equity indexes are trading mixed shortly after the cash market opening on Friday. The blue chip Dow Jones Industrial Average and the benchmark S&P 500 Index hit new all-time highs, but without the same fanfare seen the previous session. The tech-based NASDAQ Composite is under pressure, dragged down once again by worries about the microchip sector.

The narrative this week has been stocks are moving higher because an easing of concerns over the U.S. – China trade dispute, but I think you can also throw in strong corporate profits and a robust economy for recent gains.

Should Investors Be Worried?

There is a since of euphoria in the markets. Volatility is down as determined by the VIX. This is sometimes called a “why should I worry” indicator. Traders may think the trade dispute is not an issue, but it can develop into one if it continues to escalate. Traders aren’t worried about rising rates either. This week, the benchmark 10-year U.S. Treasury note yield rose to its highest level since May. Furthermore, the 30-year Government bond yield neared the psychological 3.25 percent level.

President Trump’s lingering legal issues don’t seem to be rally stoppers either. Additionally, investors are showing little reaction to the upcoming mid-term elections in November. The outcome of these elections could shift the power in Washington.

The next earnings season begins in about three weeks. It may be too early to worry about earnings at this time, however, these reports will cover the first full quarter of tariffs so we may start to see an impact if any.

Reshuffling Volatility

However, if you’re a contrary thinker then you should be aware of a couple of events today that could shake up traders a little into the close. Investors should be aware of an S&P 500 sector reshuffling later this afternoon and the quadruple-witching hour.

The reshuffling will send Google-parent Alphabet, Netflix, Facebook and Twitter to the telecommunications services sector. That sector will also be renamed communication services starting Monday. Disney and CBS will also be added to the revamped sector.

The people at S&P are saying that the moves will lead to a 21.4 percent loss in market cap for the consumer discretionary sector and a 19.5 percent drop in tech’s market value. Meanwhile, the new communication sector will represent 9.8 percent of the S&P 500, up from the current telecom’s size of 2 percent.

Traders are not expecting a large move when the new sector starts trading on Monday, but we could see volatility in some media stocks. Traders who have built portfolios based on certain sectors may have to scramble to buy the new stocks in the sector, and sell those stocks which are leaving the sector. This may cause a huge order imbalance late in the day, similar to a reallocation of the Russell Index in June, or the addition and subtraction of stocks in the S&P 500 Index, NASDAQ, or Dow.

Quadruple Witching Volatility

As it does four times a year, the Quadruple Witching – the day when futures and options on indexes and individual stocks expire – should be watched carefully for late session volatility. Traders may already be taking precautionary positions with intraday volume already exceeding normal levels for this time of day.

While the Quadruple Witching is enough to trigger a volatile reaction in the markets, when combined with the S&P Reclassification and already heightened volatility because of the new all-time highs reached earlier today, the markets could be set up for unprecedented volume and intraday volatility as we approach the close.

We don’t expect these to be trend changing events, but investors should brace for the possibility of wild swings at the end of the day. There may be trading opportunities late in the session, but make sure you have both sides of the market covered and your seatbelt on. Only then can you really enjoy the ride.