One of the popular tools used by traders in global commodities is the Commitments of Traders (COT) report published by the Commodities Futures Trading Commission (CFTC). This report provides a breakdown of open interest for markets in which 20 or more traders hold outstanding positions. It provides a breakdown of the positions held by three different types of traders: “commercial traders,” “non-commercial traders” and “non-reportable traders”.
Commercial traders are hedgers who hold an underlying buy or sell position in a commodity. If an oil producer bought a futures or options contract in crude oil for hedging purpose, he will be classified as commercial trader but if some hedge fund buys option or futures in oil then he will be classified as non-commercial trader. If there are some small traders speculating in oil and if the volume of trade done by him is small then it will be classified as nonreportable.
COT excludes nonreportable. The “nonreportable” open interest in a futures market is determined by subtracting the open interest of the “commercial traders” plus “non-commercial traders” from the total open interest in that market. As a rule, the aggregate of all traders’ positions reported to the CFTC represents 70-90 per cent of the total open interest in any given market.
According to the COT report released on September 11, speculators or the non-commercial traders have been quite bullish on crude oil. There were a total of 380,849 contracts on the long side in oil futures (NYMEX) compared with 132, 2184 contracts on the short side, a bullish figure of 188.1 per cent. Similarly there were 144,549 contracts on the long side in Brent crude and 49,826 contracts on the short side, a bullish figure of 190.1 per cent. These figures are historically high and chances of prices rising further are low.
Hints from the options markets are indicating a bearish sentiment in the oil market. Risk reversal, which is a difference between the volatility of the call options and the put options of the same contract specification, have turned negative. A negative risk reversal indicates that traders are paying more for the downside protection and is taken as a bearish signal.
For example a November 25 delta skew or risk reversal, of calls minus puts, is a negative 0.45 suggesting a slightly bearish sentiment. The skew changes to negative 1.92 per cent for the December 2012 contract implying a more bearish sentiment over longer term. Twenty-five delta skew is the difference between the volatility of 25 delta call and 25 delta put where 25 delta call is the call where there is approximately 25 per cent chance of the option expiring in the money. Higher negative numbers indicate bearishness. If the risk reversal data remains negative for extended period, the risk of a sudden fall increases. Risk reversal of negative 2 per cent or lower is considered extremely bearish.
Risk reversal changes according to market conditions so if prices fall or situation in West Asia gets worse or there is a disruption in supply or production of oil risk reversal can again turn positive.