Speculators Bigger Players in Futures, Options Markets Than Thought

Includes: CME, GS, ICE, JPM, MER, MS, NMX
by: Donald Johnson

Speculators hold 49% of oil futures and options contracts, much more than the 38% previously thought, The Wall Street Journal reports here. The impact graphs in Ann Davis' Aug. 15 story:

The scale of the recent revision and questions about the reliability and transparency of data in this market are feeding into efforts by Congress to impose restrictions on energy trading. Four Democratic senators on Thursday called for an internal CFTC inspector-general investigation into the timing of a July 22 release of a report led by the agency. That report concluded speculators weren't "systematically" driving oil prices. Oil prices soared until mid-July before beginning a decline. A letter by the senators asks why the report was released before full reviews could take place of trader information the agency only asked for this summer. Also at issue is whether the report played down speculators' influence, notwithstanding the report's finding that "the positions of non-commercial traders in general, and hedge funds in particular, often move in the same direction as prices."

In other words, the CFTC's taskforce report doesn't deserve the credibility that the futures industry and institutional speculators like pension funds and hedge fund operators are giving it. Most important, the Journal reports,

Lehman Brothers analysts say the CFTC data, as they are now reported, fail to distinguish certain categories of financial traders from commercial traders and create "an opportunity for the activity of less-informed, purely financial investors to distort expectations."

So, until the CFTC's Sept. 15 report becomes available, there is no way that the futures exchanges or its members can deny the disruptive roles of institutional speculators in the futures markets. Indeed, the public comments by many hedgers strongly indicate that institutional speculators have been and are disrupting those markets. Note, also, that the Journal for the first time refers to institutions as speculators, not as "investors." There are no "investors" in the futures markets, only speculators and hedgers.

The debate, then, is whether large institutional speculators will have to play by the same rules as other speculators. The reason that they're distorting the market is that they are exploiting loopholes in the rules that allow them to trade more than smaller speculators and to trade off the exchanges. The loopholes are designed to make Wall Street's brokers who hedge the institutions' off exchange swaps bets on commodites on the futures markets incredibly profitable.

That those loopholes are approved by the CFTC has made that regulator extremely defensive when it comes to investigating the roles of institutional speculators in the futures markets. The Journal's latest report supports my posts yesterday, which are here and here.

If Congress forces the CFTC to impose new trading limits on institutional speculators in the futures markets, how will that affect companies like the CME Group (NASDAQ:CME), which owns the Chicago Mercantile Exchange and Chicago Board of Trade? CME is in the process of buying Nymex Holdings (NMX), which owns the New York Mercantile Exchange where most energy futures contracts are traded. And how would the new limits affect brokers like Goldman Sacks (NYSE:GS), JP Morgan (NYSE:JPM) and Merill Lynch (MER)? Their daily charts are here.

Yesterday's post on futures speculators is being discussed on Seeking Alpha here.

Full disclosure: I have never had a vested interest in the futures industry, and I don't trade futures or options on futures contracts. I own JPM.