Various types of hedgers and speculators interact in derivatives markets. Floor brokers for example, may take positions, process information, and discover prices in these markets while serving clients. In addition, arbitrageurs in derivatives markets may also serve to alleviate price discrepancies and to improve the transfer of risk amongst investors. As derivatives markets continue to expand, a natural question is to what extent changes in the magnitude and the composition of trading affect pricing.
In this paper, we use a unique dataset of New York Mercantile Exchange (NYMEX) trader positions to document the significant growth in West Texas Intermediate (WTI) crude oil futures market since 2000. We utilize proprietary details about trader positions from the Commodities Futures Trading Commission's (CFTC) Large Trader Reporting System (LTRS) to show that this growth can be traced to a diverse set of trader types.
We find that increased participation by dealer/merchants, hedge funds and especially commodity swap dealers and arbitrageurs contribute significantly to improved price efficiency in one and two-year contracts. In this regard, we demonstrate how increased participation by both commercial and non-commercial traders can enhance market quality in commodity markets.
The NYMEX crude oil futures market has grown steadily this century across all futures expiration dates. In nearby contracts (those expiring within three months) where price discovery is centered, daily net positions have grown by 145% from early 2000 through mid-2006. Growth has been even more dramatic in long-dated contracts (those expiring in three years or more), exceeding 262% over this same time frame. Contracts for six or more years did not exist prior to 1999. As recently as 2000, the crude oil futures market was relatively illiquid at the far end, with open interest in long-dated contracts amounting to less than 4.5% of total open interest. For most categories of traders, however, we find that growth in the long-dated market has now made the size of daily net positions in long-dated futures comparable in magnitude to the size of the nearby market in 2000.
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Market Growth, Trader Participation and Pricing in Energy Futures Markets
