Big Picture . How to use Commitment of Traders report

With elevated levels of volatility in commodity trading these days, price-based indicators are swinging wildly, posing a challenge to decision-making.

How about an indicator that neglects the price volatility and instead tells us the bigger picture by keeping a tab on fund flows? The Commitment of Traders report, often referred to as COT or COTR, is one such indicator that shows the positioning of market participants in futures and options contract of various asset classes.

Published every Friday by the Commodity Futures Trading Commission (CFTC) of the US, the report essentially records the open interest, ie, the number of outstanding derivative contracts of different asset classes. While it is not uncommon to identify the open interest levels, the standout feature of COT is that it provides the breakdown of who holds how much.

Types of COT reports

The CFTC comes out with four main types of reports. They are legacy report, supplemental report, disaggregated report and traders in financial futures (TFF) report. A major difference between these reports is the way in which it classifies participants and the underlying asset classes.

Of these reports, most experts prefer the legacy report.

While the legacy report consists of various asset classes, it classifies traders into two categories —commercial and non-commercial traders. Commercial traders include producers, hedgers and large physical traders, whereas non-commercial traders include hedge funds and other large institutions that intend to make profits by trading. The supplemental report comprises 13 select agricultural commodities, and segregates traders as commercial, non-commercial and index traders.

The disaggregated report, too, categorises assets into different classes and separates traders into four categories — producer/merchant/processor/user, swap dealers, managed money and other reportable.

Here, the first two are the commercials and the latter two the non-commercials.

In the financial futures report, traders are classified as dealer/intermediary, asset manager/institutional, leveraged funds and other reportable.

How it is prepared

The report is prepared based on the data submitted by intermediaries such as exchanges and clearing houses.

All contracts which have 20 or more traders who hold more than a specified number of positions are taken into account.

The futures-only report is compiled by adding the open interest of futures contracts. On the other hand, for the combined futures and options report, futures-equivalent options contracts (multiplying the option contract positions by their delta value) are added to the number of futures contracts.

If 1,000 options contracts with delta of 0.5 is outstanding, the number of futures-equivalent options contracts here will be 500.

Interpreting the report

A typical COT report separately mentions the long and short positions held by both commercial (hedgers) and non-commercial (large speculators) participants.

Notably, there is a column for spreads which denotes the extent to which the non-commercial traders hold equal long and short positions, ie, the number of outstanding contracts that have been created within the non-commercial category.

Simply put, the counter positions for those contracts are not from commercial or any other category. The report also mentions the percentage of open interest each category holds and the number of traders as well.

One important reason for commercial traders to take positions could be hedging. So, it is the positioning of non-commercial traders (large speculators), who try to capture the price trend, that can come in handy.

In general, they are believed to be directionally correct and their views are changed less frequently. So, it can be worthwhile to track how these large traders position .

All the data below are taken from short format futures-only legacy report for gold.

During early 2019, the price of gold declined between February and May, from about $1,360 to $1,320. In the same period, the non-commercials (large speculators) increased the longs from 2,18,200 to 2,26,361 contracts while reducing the shorts from 1,09,105 to 1,01,825 contracts. Effectively, the net long position went up from 1,09,095 to 1,24,536 contracts.

This means that the large speculators added long positions despite declining price. What followed was a strong rally to $1,575, which was accompanied by a further rise in net open interest.

Now, considering the reports since March 2020 up to the most recent report available (dated April 28, 2020), it can be observed that the non-commercials (large speculators) have been reducing both long and short positions. Longs are down from 3,17,405 to 2,87,382 contracts, whereas shorts are down from 35,489 to 24,653 contracts.

Importantly, the net long positions are down from 2,81,916 to 2,62,729 contracts, as longs are liquidated at a faster pace.

The price, on the contrary, has rallied from nearly $1,500 to about $1,730. Hence, the large speculators seem to cut back longs on rallies. Though this may not be an outright sell signal, the rally seems to be weak and the probability of a reversal increases if the net open interest remains unsupportive of the price.

It is vital to track how the contracts are being built or liquidated over a period rather than relying on a single day report.

COT can be of advantage as it gives a holistic picture on the expectation of each market participants. Also, extreme positioning can be identified with enough past data.

However, it has its own shortcomings. For instance, the three-day lag with which the report is published.

This misses out the most recent action which is undesirable for short-term traders.

And, extreme positioning does not necessarily warrant an immediate reaction as markets can stay over-bought or over-sold for longer period.