Tag Archives: small speculators

Stock Index Futures Expiration Tendencies

Commercial traders in the stock index futures behave quite differently than the Index traders or, small speculators who act as their counterparts. Collectively, this is perfectly logical. Index traders are positive feedback traders. Positive feedback traders add on to their bullish positions as the market climbs and scale out of their bullish positions as the market declines. This keeps their portfolio balanced to their available cash resources. This also places them on the side most likely to buy the highs and sell the lows. Typical trend following. Small speculators are a sentiment wild card. Their position is more price and sentiment based than anything else. The randomness of their sentiment makes their positions too yielding to lean on.

Commercial traders, on the other hand are negative feedback traders. Their strategy is a mean reversion, value based methodology. Collectively, their models tell them what price is, “fair.” The higher the market gets above their fair value, the more they sell. Conversely, the more the market falls below their fair value, the more they buy. Their direct actions typically trace out the meanderings of a wandering market placing their sell signals atop the market’s intermediate rallies and their buy signals below the intermediate lows.

There are two other aspects of commercial traders’ habits that must be examined before we approach the current outlook. Commercial traders use the stock index futures to hedge their equity portfolios. Their ability to sell short the stock index futures provides them with easily implemented downward protection against a decline in their equity portfolio. Furthermore, direct short sales in the stock index futures avoids the uptick short sale rules in equities along with the avoidance of accounting for capital, gains or losses as well as any changes in basis. This aspect of their behavior is observed by the varied but consistent, slightly negative correlation between the commercial net position and the underlying market.

The second aspect of commercial usage of the stock index futures is their implementation of options and the corresponding trades this forces them to execute in the stock index futures. Just as commercial traders maintain a slight short bias in the futures to protect against equity declines, commercial traders also sell upside calls in the options market in order to collect the premium and lock in some short-term gains.  Selling call options creates an instant credit in the trader’s account but similar to unearned income this cash is actually a liability whose profit is realized over the course of time. The short call option creates a net short position in the futures market. Commercial traders use the markets’ declines to jump in and buy enough futures to offset the upside liability created by the short call options thus, locking in the added alpha they collected upon the initiation of the short call option position.

Now that the basics are out of the way, let’s look at how this plays into the current market situation. Three out of the last four quarterly futures and option expirations have seen some very specific trading behavior by the commercial traders. Better yet, it’s been easily traceable as you can see on this S&P 500 futures chart  The market starts acting up around a month prior to expiration. That places us about a week out from the beginning of what I’m expecting from the June expiration and the June pattern has been the most consistent occurring in each of the last five years.

The pattern plays out with commercial traders pressing the market lower about 20-30 days prior to expiration. This decline accomplishes several tasks. First of all, it washes out the weak small speculative long position. Second, it’s far enough to force index sellers to lay off part of their portfolio. Finally, its far enough for the commercial traders to cover their direct short hedges as well as allowing them to get futures bought against their short call option positions at a discount. This buying has been enough to run the market straight back up to the highs and create a new churning pattern of consolidation at the highs leading into expiration.

This leaves the market sitting near the highs again and creates the same scenario of index buying and small spec buying that helps grind the market higher, yet again. It’s clear the way this has played out over the last few years that the commercial traders are in fact the only beneficiaries of these late quarterly cycle gyrations. However, it’s also clear that their footprints are easy to track including one of our recent pieces, “Commercial Traders Own the Stock Market Gyrations.” While we feel this is true most of the time, we feel far more certain given our current place in the stock index futures’ quarterly expiration cycle.

End of the Sugar Decline

The sugar market, currently trading around $.17 per pound has been drifting slowly lower since making its all time high of $.2957 per pound in August of 2011. Last week, the market fell through a key support level at $.1662 and traded down to $.1617 before reversing to close on its highs for the week. This could very well be the catalyst to rising sugar prices over the next few weeks.

The sugar market can be exceptionally volatile. Sugar’s average annual movement over the last five years is about 225% from high to low. This year, we’ve only seen a 20% range between the high and low. We expect volatility to increase with range expansion for the year’s range to show up in new highs. We also expect a near term increase in volatility as the market rejects the recent low and reverses course.

The sugar market’s decline has been quite orderly. This means there’s been low volatility. Low volatility compresses risk levels, which leads to tight stop prices. Tight stop prices allow more people to access the market. Tight stop prices also lead to added leverage. Smart traders view risk as a percentage of equity. Tight stop placement allows traders to add multiple contracts while maintaining their own risk tolerances. This ease of access and tight stop placement leads to ballooning open interest. Open interest recently peaked at just over 450,000 contracts. This is the largest open interest since January of 2008.

Staying with the technical characteristics we can compare the change in open interest to their price levels. Tying these observations to the Commitment of Traders reports then allows us to assign the change in open interest to individual trader categories like small speculators, index funds and commercial traders. This type of analysis shows that there were 95,000 new contracts added between March 1st and today. These contracts were all initiated between $.1684 and $.1778 per pound. Furthermore, the build in the commercial trader positions since mid-March is almost exactly 90,000 contracts.

The final technical piece lies in reading the chart itself. The weekly sugar chart shows last week as a key reversal bar. The textbook definition is a chart bar that makes a new high or low for the extended move indicating continuation of the trend before pulling an abrupt about face and closing beyond the previous bar’s high or low. The rejection of this new price level and quick return to previously traded prices indicates a market that has moved too far, too fast. The details of the setup show the weekly range for the week ending June 7th as $.1666 high to $.1632 low. Last week’s reversal bar traded down to $.1617, below the previous week’s low before closing at $.1678, above the previous week’s high.

Finally, we are just beginning the strongest seasonal tendency for October sugar. The seasonal strength lies between the middle of June and the end of July. We feel that the build in commercial long positions, coupled with the large increase in the speculative short position near their current breakeven levels will ultimately resolve its imbalance to the high side.

Last week’s key reversal bar leaves 90,000 contracts in jeopardy of being stuck holding the hot potato. Given the low volatility the market has been experiencing I believe that many of those new positions have pretty tight protective stop loss orders tied to them. Therefore, as this market turns higher it should begin to trigger these stops. The buying pressure triggered by the stop loss orders could very well kick off the seasonal strength. The first trend line resistance is just shy of $.18 per pound with further technical resistance around $.20 per pound. Meanwhile, since we are in fact bottom picking, a protective stop loss order should be placed no lower than $.1683.  The primary key to profiting from this trade will be the ability to gauge the buying pressure that comes from small speculators being forced out of their short positions.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Success Breeds Success

There are several sayings intended to keep us on the right path in our financial lives and in this day of data crunching, quantitative analysis, back testing and the never ending search for the best new method perhaps none is more true than, “Success breeds success.” When I first began my trading career in Chicago, I didn’t spend much time with new traders. Partly because many didn’t last long enough to get to know their last name and partly because I was married with a young child and a lot of bills to pay. I did spend time with as many of the grizzled veterans and established traders as I could. Early on, after what had been one of my worst days, I was full of self- doubt and felt the pressure of the world on my shoulders. I sat in the member’s break room, just off the S&P 500 trading pit with my head in my hands and an untouched cup of coffee in front of me. I hear a chair slide out at my table and a graveled voice of experience ask, “You bust out kid?” I look up to see Bill Katz who had been a member since the blackboard trading days on Franklin Street. I replied that I hadn’t and his point was that as long as you get to come back tomorrow, you’re still doing something right.


The point of this story is that many people ask me questions about why I follow the weekly Commitment of Traders Report (COT), what group I follow within the report and, why. The month of November has been a great illustration across multiple market sectors. This week, I’d like to explain how it all plays out.


The Commodity Trading Futures Commission (CFTC) tabulates the weekly Commitment of Traders Report based on the trading of several individual groups of traders. Over the last couple of years, in the interest of, “transparency,” the groups have been broken into several subsets as well. For our purpose, we can break it down into the following main categories.


Large Speculators – Any trader with an interest greater than the CFTC’s reporting level in any individual market.


Small Speculators – All individual traders with an interest less than the CFTC’s reporting level in any individual market.


Non-Commercials – Any organization trading in commodity futures with substantial reporting interest not tied directly to the production or consumption of the markets that they hold reportable positions in. These include Commodity Index Traders, Exchange Traded Fund managers and swap dealers.


Commercial Traders – Producers or consumers of commodities. These are the true hedgers in the commodity markets. These hedges can be directly tied to gold, corn and oil just as easily as bonds, currencies and stock indexes.


Following the commercial traders is, “Success breeding success.” This group of traders has a fundamental understanding of value either through the production of or, the end line consumption of the commodity market in question. These people make the calls on when to stock up on raw materials for future consumption or, when to sell forward production and base their livelihoods on their ability to ascertain value.  Furthermore, in the case of publicly traded companies like British Petroleum, Con Agra or General Mills, their research entreats themselves to the good graces of their shareholders and board members.


November’s trading was an excellent depiction of this mechanism at work. This month saw very strong rallies in metals, grains and the stock markets.  In these three market sectors non-commercial traders fueled the rallies. In fact, we saw soybeans, platinum and palladium either reach or, nearly reach record historical buying levels. The one thing these markets all had in common was momentum. These market sectors had all been in established upward trends. Many of the non-commercial traders represent commodity funds and exchange traded funds, which are obligated to maintain certain percentages of each market in their portfolios to match their disclosure documents. This forces them to buy more on the way up and sell more on the way down to maintain the proper allocation percentages. Their actions in the marketplace are mechanical and take little account of a market’s value when making their trading decisions.

COT Extreme Worksheet

Commercial traders played their hands like the World Series of Poker for the month of November. These same markets that rallied on the strength of non-commercial buying managed to reach their highs just as the threats of European solvency issues and a Chinese slowdown came in to turn the tide. The proactive analysis of the commercial traders throughout these recent market tops allowed them to position themselves favorably for the markets’ coming declines.  Their selling was quite obvious on the screens and reported by the CFTC in the COT report.


These reports also show us that the commercial traders have been active buyers of the energy market, decreasing their current net short position by more than 25% in the last week. This is representative of their perception of value in the face of the sell off early in the month in a market they’re expecting to be headed to new highs sometime in the near future.


There’s no shame in following the success of others. Following value driven trading actions by people whose livelihood depends on their successful analysis rather than the trading actions of someone following an allocation formula is my present day version of finding successful traders to guide me in the break room.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.