The CFTC, Newton, and Me

• Most of the industry likes to talk about weekly CFTC Commitments of Traders report that include every possible position held at the end of each Tuesday. 
• What this does not take into consideration, though, is option positions are established for a number of reasons beyond traders' bearishness or bullishness. 
• And that is the bottom line when it comes to using the data as confirmation of trends, noncommercial activity that indicates bullishness or bearishness. 

A question I am often asked is why I track the legacy, futures only CFTC Commitments of Traders (CoT) report rather than the far more popular “disaggregated futures and options combined”. There are a number of reasons, starting with I really don’t care what the cool kids are talking about. I’ve talked to the folks at the CFTC, and admittedly they had difficulty with trader classifications over the years. As usual, adding more titles to the mix doesn’t help clear things up. In fact, as we usually see, it only muddies the situation further. 

It’s good to keep in mind what the Commitments of Traders reports are best used for. It provides a form of confirmation for what we see in futures markets, based on Newton’s First Law of Motion applied to markets: “A trending market will stay in that trend until acted upon by an outside force, with that outside force usually noncommercial activity.” You likely noticed the word “usually”. I learned a long time ago to not use absolutes when it comes to commodity market analysis and commentary, unless it is to say I never use absolutes. 

The application of Newton’s First Law of Motion led to Newsom’s Market Rule #1: Don’t get crossways with the trend. Why? Because the trend is set by large noncommercial interests that have a lot more money than most of us (notice I didn’t say “all”). Therefore, what we need from the CoT report is a general idea of noncommercial activity in the futures market. 

Why not add options to the mix? The most influential option traders aren’t necessarily interested in direction, but instead looking at the long list of Greeks that make up the pricing of options looking for profit opportunities. Given how options work, traders can be long or short, puts or calls, in some cases establishing larger positions than their cohorts in the futures markets. A good friend updated me Thursday on some large-scale option trading occurring in February live cattle (LEG22). Early in the day a three-legged spread had been put on as someone sold 1,300 contracts of in-the-money calls, bought 1,300 out-of-the-money puts, and 1,300 out-of-the-money calls. In other words, 3,900 contracts were traded to do the same thing as selling 1,300 futures contracts because the Greeks had lined up in such a way that it made sense. But it only makes the more convoluted CoT report that much murkier.