The Commitment of Traders (COT) Report is published in the USA every Friday by the Commodity Futures Trading Commission. The data is an aggregation of the positions of different groups of market participants in the individual futures markets and is traditionally considered by traders as important information.
The classic literature on commodity futures pricing is based on the hypothesis of hedging pressure according to Cootner [1] and Hirshleifer [2]. According to this, the following applies to the net positions of commercials (hedgers) and non-commercials (large speculators):
If the hedges are short, the futures should be low relative to the expected commodity price at expiration, which makes long speculation attractive (backwardation)
If the hedges are long, the futures should be high relative to the expected commodity price at expiration, which makes short speculation attractive (contango)
Where does the premium come from?
First of all, the question arises as to what premium can come from a liquid, efficient futures market. According to theory, by taking the opposite position to the hedges, a speculative premium would be justified by assuming the price risk. This premium would economically represent a kind of insurance premium.
In their investigation of whether the premium exists, the authors of the study "Speculative Pressure" [3] use the net long positions of non-commercials as a signal for speculative pressure. In doing so, they examine the informative value both in the context of a time series view (Time Series) and a cross-sectional view (Cross Sectional):
Time Series: Long (short) in futures with backwardation (contango), where the major speculators are net long (net short)
Cross Sectional: Analysis of the explanatory power of the speculative premium for price formation
Both studies show that speculative pressure is a decisive component for the pricing of the futures markets under consideration. The long-short portfolios generate positive, statistically significant excess returns that are on a par with momentum and carry premiums. The results support the theory that the non-commercials act as momentum and/or carry traders. For interest rate or bond futures, on the other hand, speculative pressure cannot be proven to be a pricing factor.
Possible trading strategy
Based on these results, a speculative premium can be achieved by systematically buying (selling) futures in which net long positions (net short positions) of the major speculators are present. According to the researchers, the returns achieved in this way have explanatory value even for portfolios that have been adjusted for momentum or carry premiums, for example.
The chart shows the performance of portfolios implementing a long-short strategy based on speculative pressure in various asset classes. The development shown is based on total returns, i.e. the premiums achieved plus the corresponding 1-month T-bill yield.
Source: Fan, J. / Fernandez-Perez, A. / Fuertes, A. / Miffre, J. (2019), Speculative Pressure, p. 39
However, the authors also point out that there is no conclusive consensus in various studies on the subject of hedging or speculation premiums. Depending on the study under consideration, the investigation method used and the time window, the premiums can be positive, negative or insignificant (close to zero).
Conclusion
A premium can be systematically earned on equity, commodity and currency futures by taking positions in the direction of the speculators.
