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Stocks could face more choppiness than usual during the lead-up to the market's next so-called quadruple witching event on Friday, warned Fundstrat's Tom Lee.
In a Monday note, the head of research said that the contract expiration event could have a bigger impact on the market because options activity has nearly doubled since the start of 2020.
In the past, the quad witching event has been viewed as a driver of short-term market volatility. The event occurs when four types of contracts all expire on the same day: single stock options, single stock futures, index options, and index futures.
With heightened interest from both retail and institutional investors, options activity has nearly doubled since the start of 2020, compared to a 22% uptick in equity volumes. This is making the market more vulnerable to quad-witching induced choppiness, Lee said.
"One reason options expiries create greater impact, is options activity is soaring relative to cash volumes," he said, noting that call volumes have exploded 92%, will S&P 500 index volumes are lower today than they were in 2002.
He continued: "Even if options are cash settled, there is impact on the underlying instruments (single stocks or indices), because of the related hedging/positioning involved in the original position. In other words, if options volumes soar, these will have an impact on stocks/indices. And to the extent options volumes surge, the expiry would have a greater proportionate impact."
During the previous quad witching in March, selling began four days before the expiration date. Lee expects stock market gyrations around Friday's event.
While "the vast majority of investors" shouldn't be taking any action, Lee prefers to trim positions early this week and buy stocks towards the middle of next week.
The strategist emphasized that the "future is uncertain" and his predictions could "be totally wrong."
"However, recall, we wrote a similar analysis of quad witching ahead of the March expiry. And indeed, the March 19th 'quad witching' created some chop," he added.
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