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Definition:
The maximum position, either net long or net short, in one commodity future (or option) or in all futures (or options) of one commodity combined that may be held or controlled by one person (other than a person eligible for a hedge exemption) or group of investors acting jointly as prescribed by an exchange and/or by the Commodity Futures Trading Commission (CFTC).
Definition as stated on InvestorDictionary.com
Position limits were designed for the purpose of maintaining stable and fair markets. They are in place to accurately gauge the level of control over a single security or option contract held by one party. Each option and/or futures contract will have varying position limits.
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Money Management Knowledge Base:
Position limits have been an integral part of futures trading in the United States for over one hundred years. The first legislation to regulate, ban, or tax futures trading was introduced in the US in the 1880’s. This came as a result of the relationship between the performance of commodities in the futures markets and the performance of the stocks of companies who rely on those commodities to do business. In 1936, the Commodity Exchange Act (CEA) was enacted. The CEA extended regulatory powers to include the authority to establish federally mandated speculative position limits. Since its enactment, the CEA has stated that any excessive speculation in any commodity traded on a futures exchange which causes sudden or unreasonable fluctuations or unwarranted changes in the price of such a commodity is an undue and unnecessary burden on the economy. In 1974, The Commodity Futures Trading Commission Act overhauled regulatory legislation dealing with position limits and created the Commodity Futures Trading Commission (CFTC). The CEA has directed the CFTC to establish such limits on trading that the Commission finds are necessary to diminish, eliminate, or prevent strains on the economy. Under this statutory mandate, the CFTC directly fixes the position limits for many commodities and also allows the exchanges to use “position accountability levels” rather than fixed limits in months other than the spot month for commodities that meet liquidity requirements. These regulations are necessary due to the possible impact that fluctuations in the futures markets can have on the stock market and the broader economy. If speculation leads to an increase in the price of commodities then consumers will have less funds to spend on goods and services, thus negatively impacting the economy and the stock market. The passage of the Commodity Futures Modernization Act (CFMA) in 2000 created a flexible structure, clarified oversight jurisdiction, and repealed the ban on trading of single stock futures. The CFMA also created a key change in position limits, which allowed many participants to be re-classified from non-commercial to commercial. Commercial participants are considered to be entities that have a legitimate physical need for these commodities for business purposes and as such have little to no regulatory limits on the quantities they trade. This re-classification contributed to an increase in speculation in the futures market and a de-linking of price from the fundamentals among many commodities. The futures market has historically served as a leading indicator for the stock market due to its reflection of supply and demand fundamentals. A de-linking of these fundamentals from the price of the commodities eliminates the futures markets ability to act as a reliable indicator for stock market price discovery.
Position limits continue to be a relevant area of debate. In his statement on January 4, 2011, Bart Chilton, Commissioner of the CFTC, discussed using an interim position point system while a more modern position limit proposal is being drafted. According to Chilton, the point system would be used primarily as a red flag system that would bring to the attention of the CFTC any trading activity that may or may not be in violation of position limits. It would serve as a gauge to determine a traders net position on a given security, commodity, or future. If a traders’ net position is beyond a speculative position point the CFTC would begin to gather information to determine what, if any, action should be taken.
Chilton also stressed in his comment that the interim position point system would not be the hard and fast guidelines of a congressionally supported position limit system. He also felt that there was an immediate need to address excessive speculation in the markets that could result in certain commodity prices being “delinked from supply and demand fundamentals, and are being impacted by excessive speculation”. Chilton closed out his remarks by stating that while an interim position point system may unfortunately be the best thing the CFTC can do at this time, a “delayed implementation in the Commission proposal exacerbates this already troubling set of circumstances”. Commissioner Chilton is not the only one concerned with the adverse effect of uncheck speculation in commodities markets. The United Nations has also found that unchecked speculation in the futures markets can have an adverse effect, and was a contributing factor in the global food price crisis of 2007 and 2008. For more information on the U.N. report, please see “Food Commodities Speculation and Food Price Crises”, an article on the U.N. findings.
To gauge the effect that fluctuations in commodities futures markets can have on the economy or stock market we looked at how price fluctuations in crude oil futures translates into real dollars for the U.S. economy and the companies that contribute to it. In 2010, it was estimated that the United States was consuming, on average, 19,267,530 barrels of oil per day. So for every dollar increase in the price of oil futures, it costs the U.S. about $19,267,530 more per day, or a little over $7,000,000,000 per year. If America were a company, that extra $7,000,000,000 per year would be considered an expense and detract from its profitability. This same logic holds true for individual companies. If the cost of operations rises, or falls, it affects the profitability of the company and would be reflected in that companies stock price. This is a simple example of how commodities futures market behavior can affect the performance of the stock market.
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