*This blog post was updated in October 2020.
In this series, FundApps will explore some of the more complicated aspects of position limits in detail. We'll be covering regulation set by the CFTC, and later in the series, MiFID II and the HKEX.
What are CFTC Position Limits?
Position limits, or exchange-traded derivative limits, are a regulatory tool to monitor or restrict market participants on the amount of commodity futures contracts they can hold. In the United States, they were introduced by the Commodity Futures Trading Commission (CFTC) in Title 17 of the Code (CFR). The Commodity Exchange Act requires that markets adopt position limits and authorises the CFTC to impose these limits. CFTC Position Limits are particularly focused on trades during the delivery (spot) month, but also apply to other positions.
The CFTC makes provisions for the exchanges to set the specific position limits that can be accumulated by the market participant on their exchange. This power may be exercised by the exchange on a discretionary basis, allowing exchanges to have limits different to those set by the CFTC on 28 designated physical commodities. For this reason, position limits in the US can vary widely from one exchange to another. In addition to different limits, the methods for calculating a market participant's holdings also vary from exchange to exchange. However, there are two main ways that limits can be calculated (excluding accountability and reporting levels).
Under the CFTC, limits typically apply as follows:
- Spot months;
- Single months and all months (which are referred to as ‘non spot months');
But what do these mean, and how are they calculated?
Spot Month:
Spot month position limits apply in the period immediately before delivery obligations are incurred for physical contracts, or a period immediately before contracts are liquidated by the clearing house based on a reference price for cash settled contracts. The term does not refer to a month of time.
They are specific to each commodity contract and will generally be set at 25% of the estimated deliverable supply.
Spot limits are applied separately for physical and cash settled equivalent contracts. A market participant may therefore hold positions up to the spot month limit in physical contracts, as well as positions up to the applicable spot month limit in cash-settled contracts. Netting across cash and physically settled contracts is prohibited when determining compliance with the spot-month limits, so separate calculations must be made. Note that not every exchange has limits pertaining to delivery month.
Non Spot Months (Single and All Month):
Non-spot month position limits apply, in addition to spot month limits, to contracts a holder has in all contract months combined or in any single contract month. All months refers to the sum of all futures trading months.
In contrast to spot month limits which are based on estimated deliverable supply, non spot limits are based on open interest for all contracts in a base commodity. For each contract, the limits will be set according to the CFTC at 10% of open interest in the first 25,000 contracts and 2.5% thereafter. Open interest used in determining non-spot month position limits will be based on futures open interest, cleared swaps open interest, and uncleared swaps open interest.
Open interest is the total number of open or outstanding contracts which have not been settled by either counterparty. The open interest position increases when a buyer and seller create a new contract by the buyer taking a new long position and the seller taking a new short position. It decreases when an existing open contract is closed by either counterparty either by offsetting or exercising it. It does not change if an existing trader passes his or her open contract to a new trader without closing it. It is shown as a positive or negative number and it is updated at the end of every trading day, not intra-day. When calculating open interest, either all the buyers or all the sellers to contracts in a market must be aggregated to avoid double counting.
