Position limits are restrictions set by the Commodity Futures Trading Commission (CFTC) that limit the trading and position-holding on certain commodities. The CFTC specifies, for example, the maximum position that one person or entity can hold open, in a single month or all months, in corn, oats, wheat, soybeans, soybean oil, soybean meal, and cotton.
A position is the degree and type of investment a person or entity has taken regarding a particular asset, security, property, or market. Positions can be long, signaling a bullish (i.e., optimistic) view, or they can be short, signaling a bearish (i.e. pessimistic) view.
The size of positions is measured in contract units, which are the amount of an asset (e.g., 100 barrels of oil) presented in a derivative. A derivative is a kind of contract that can be traded, getting its value from the value of the underlying asset (e.g. a commodity such as wheat).
- Futures contracts are one example of a derivative. In a futures contract, parties have agreed to a set price for the purchase and delivery of an asset at a future date. When investors trade futures, they are speculating about the potential price difference between the assets on the date of sale compared to the prices specified in the futures themselves.
- For example, a flour milling company that knows it needs 1,000 bushels of wheat on a particular date may choose to purchase futures at the current price (e.g., $5 per bushel) in anticipation of a price increase (e.g., $10 per bushel) by the time of purchase and delivery. If the company is correct and still holds the futures at the time of purchase and delivery, it has saved the difference (in this case, paying $5,000 instead of $10,000). The company would, however, expose itself to the risk that prices would drop. If at the time of sale the price has dropped to $1 per bushel, then the company will pay $5,000 for assets worth $1,000.
The Commodity Exchange Act, 7 U.S.C. § 6a(a), authorizes the CFTC to “proclaim and fix such limits on the amounts of trading which may be done or on positions that may be held” of commodities in which “excessive speculation” has caused “sudden or unreasonable fluctuations or unwarranted changes in the price” of the commodity. Once those limits are set, § 6a(b) makes it unlawful “directly or indirectly to hold or control a net long or a net short position in any commodity for future delivery . . . in excess of any position limit fixed by the Commission for or with respect to such commodity.” But “bona fide hedging transactions or positions,” however, are exempt from this rule. See § 6a(c).
Position limits are supposed to be determined by formula for each commodity class. The determining factor in this formula is the previous calendar year’s average combined futures and delta-adjusted option month-end open interest. If that number is fewer than 25,000 contract units, the position limit is set at 10% of it. But if the previous year’s average month-end interest is greater than 25,000 contract units, the position limit is 2,500 plus 2.5% of however much the average month-end interest is greater than 25,000. If the previous year’s average month-end open interest was 10,000 contract units, for example, then the formula would set a position limit of 1,000. If the previous year’s average month-end open interest was 200,000 contract units, the formula would set 2,500 for the first 25,000 contract units and 4,375 for the rest (2.5% of 175,000), for a combined 2,500 + 4,375 = 6,875 contract units.
Spot Month
A spot month is the month in which a futures contract matures and becomes deliverable. Because physical delivery is required in that month, excessive positions and disorderly trading practices can be particularly disruptive. In consequence, position limits are stricter in the spot month.
The Commission’s Acceptable Practices Principle 5 provides that the position limits specified for the spot month should be determined according to an analysis of deliverable supplies and the history of spot month liquidations. Cash-settled markets should have spot-month position limits at a level no greater than necessary to minimize potential manipulation. These guidelines are codified in a formula, which sets the spot-month position limit at 25% of the estimated deliverable supply at the futures delivery point. If the deliverable supply for an entire crop year of corn futures is 12 million bushels, for example, then 25% of this amount is 3 million bushels. Each corn futures contract, meanwhile, represents 5,000 bushels. Dividing 3 million by 5,000 gives the spot month position limit of 600 contract units.
Single-month and all-month limits have been in place since December 2005, notwithstanding that agricultural futures contracts have seen significant growth since that time. Spot month limits, in the meantime, have not increased since 1999. The exchange markets are therefore operating under position limits that are significantly stricter than they would if current data were properly used in the formulas.
For commodities other than those specified in the table, the CFTC authorizes the exchanges to set their own position limits. On these commodities, the exchanges can impose, in lieu of position limits, “position accountability” requirements,[1] which allow the exchanges to ask high-volume traders for information related to the hedging and strategic nature of a heavy position. This information facilitates detection of attempts at market manipulation.
Hedging Exemptions
One function of futures markets is to allow commodity holders that are averse to the risk of price movements in their held commodity to transfer that risk to firms or individuals who are tolerant of such risk. This transfer of risk occurs through a “hedge,” in which as-yet-unproduced commodity units are sold at current market prices. The buyer of a hedge - often referred to as a speculator - bears the pricing risk, betting that the commodity will increase in price.
Because they transfer risk to the most efficient holders, hedges constitute value-adding transactions. The CFTC therefore exempts “bona fide hedgings” from position limits. “A bona fide hedging transaction or position is a transaction or position [that] . . . [(1)] represents a substitute for transactions or positions made or to be made at a later time in a physical marketing channel (‘temporary substitute test’); [(2)] is economically appropriate to the reduction of price risks in the conduct and management of a commercial enterprise (‘economically appropriate test’); and [(3)] arises from the potential change in value of actual or anticipated assets, liabilities, or services (‘change in value requirement’).” Additionally, “a transaction or position that qualifies as a pass-through swap and pass-through swap offset pair is a bona fide hedge.” In the event that an exemption is given, the exempted firm cannot take a limitless position; it just faces a higher position limit. Some exchanges disable or restrict hedging exemptions in the last few days of a delivery month.
Definition of a Person
Responsibility for futures-market manipulation is often distributed across multiple firms or entities working in collusion. If these colluding entities were treated as multiple persons for the purposes of position limits, it would defeat the purposes of the Commodity Exchange Act. Commodity Exchange Act § 6a therefore provides that any persons or entities working jointly or under an agreement in holding a regulated commodity will be considered a single “person” for the purposes of position limits.
In terms of joint ownership, two (or more) holders of commodity interests are treated as a single person for compliance with position limits if one holder has a 10% or greater financial interest in the other. The size of a person’s interest is not determined proportionally by the person’s fractional stake in the holder - the person is treated as owning the whole of the holder’s position. For example, if firm B has a position of 600 contract units in corn, and person A has a 50% ownership stake in firm B, person A is treated as having a position of 600 contract units, rather than 300 contract units. Similarly, two or more separately owned firms acting under an express or implied agreement are treated as a single person for the purposes of position limits.
The CFTC also treats a pool of traders as a single trader. Limited partners and pool participants that have no knowledge of or control over the positions of the pool are exempt from this aggregation rule, as are commodity pool operators or commodity trading advisors with commonly owned but independently controlled positions.
See: 17 CFR Part 150 - Limits on Positions; 7 U.S. Code § 6a - Excessive Speculation
[Last updated in April of 2024 by the Wex Definitions Team]