Commodity Futures Trading Commission (CFTC) under fire for failing to discourage speculation in oil and grains futures
Kirsten Zella
Jul. 6, 2008

What happened in the oil and grains futures since middle of 2006 is a real shame for any one who understands how commodity futures and options of these futures work. Producers, intermediaries, commercials and the speculators trade futures. Speculators were small entities before 2006. Since 2006 the ETF, hedge and private equity funds have tried to use the futures market like the stock market. These managers never traded futures before. They were essentially stockbrokers and mutual fund managers. All on a sudden they decided like subprime stupidity they must jump into commodity futures pits. They were actually driven by the competition to produce 100, 200 or even 300 % profits.

Speculators in the commodity futures seldom make money. 999 out of 1000 investors are real losers. It takes on an average 20 years of losing commodities to make a successful commodity futures trader. There are professional commodity trading advisors (CTA) who call themselves ‘experts’. In reality the max they make over a long period of time (one in a thousand) is around 25 to 30%. Most of the CTAs actually lose money.

The speculation in a commodity is controlled by margin set by the CFTC. When oil starts moving up sharply, its margin is also increased sharply. That makes the small speculators shy away from the oil market. But CFTC never understood that the former stock players that are funded with hundreds billions of dollars are speculating in the futures markets. Like subprime mortgage fiasco these little educated ETF, hedge and private equity fund managers thought futures market is nothing but a high speed stock market.

As these billions of dollars made its way into wheat, Corn, Soybean, oil, gasoline and other commodity futures, prices moved up. The CFTC increased the margin from $1000 to $1500. Normally in the stock market, you can only buy $2000 worth stock with $1000. Right now these moron fund managers are buying $140,000 worth crude oil with only $7250 maintenance margin money. For these funds, $7250 per contract is nothing.

CFTC failed to understand that the commodity speculators are now big billion dollar players. These large entities move the commodity markets with such high volatility that small speculators are almost pushed to the sidelines. Oil market is a good example. The speculative futures contract have gone up in open interest (number of open futures contracts trading in the market place) ten folds but the number of options contracts on the same commodity are basically unchanged. Small speculators who are really sophisticated are still making money with options as the hedge. When you use futures and options together, for example, buy owning oil future, selling call and buying put, the effective volatility and the maintenance margin comes down 10 folds.

The fact that oil futures contracts went up ten folds without much of a change in options contract shows how ineffective CFTC is in maintaining appropriate margins.

When oil will fall, these same fund managers will lose their and their clients’ shirts. Just like Bear Sterns, they will run towards the Federal Reserve chairman Bernanke to bail them out with trillions of dollars printed fresh from the Government press ballooning the budget deficit.

The margin in crude oil in this environment should be $30,000 and not $7250. After stock market crash in 1987, the margin on stocks was made very high. CFTC has failed to increase the margin adequately fueling speculation by mega billion dollar financial institutions, ETF funds, hedge funds and private equity funds.

Washington lawmakers are finally moving. They should read this article and educate themselves. The House Agriculture Committee will host hearings examining whether the Commodity Futures Trading Commission has a strong-enough grip on the fast growing, $5 trillion futures market for oil and other commodities or needs other tools. It also will examine how that the $9 trillion “over-the-counter” market that has mushroomed outside CFTC regulation affects market.

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