Folks, today is the big quarterly expiration, the day when all the June front-month futures and options contracts expire. We’ve gone over serial expirations before, and today I want to talk about how these “quadruple witchings” are a little different than the monthly ones.

Along with the hundreds of billions of dollars in synthetic positions replicating the S&P 500 rolling over today, June expiration also includes a rebalancing within the indices. Simply put, the actual composition of an index changes—stocks are taken out and replaced with new ones.

Let’s say IBM is not in the S&P (which it is) and Woolworth is in the S&P (which it isn’t). Today, the S&P decides it’s going to boot out Woolworth and add IBM. The fund managers need to shift accordingly, i.e. get short Woolworth and get long IBM.

Why is this important?

Because it’s not just an even swap. Woolworth is, say, a $200 million cap, whereas IBM is maybe $200 billion. So in order to get long the new issue, fund managers need to raise additional capital. To do that, they liquidate portions of their overall S&P holdings in order to buy IBM. This selling creates volatility, and for traders, volatility means opportunity.

Pay attention to what happens right after this expiration. If we’re going to see a surprise summer rally—which I still believe we are—it’s probably going to happen in the next couple of weeks. We heard a lot of noise about how we’d see pressure to the sell side at expiration, but I think that big selloff a couple of days ago triggered the models and got people to jump the gun a bit. That, plus yesterday’s indecision, may foreshadow a bounce in the second half of today’s session.

Meanwhile, that 10-year is still under 3% and the pullback remains within that 7% sweet spot. The spring is loaded and there’s relative value in the markets. The chatter may be negative, but I’m a contrarian—I still see tremendous opportunity on the buy side.
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