The two types of participants are commercials and noncommercials. The three categories of participants are commercials, noncommercials, and nonreportables. Positions in the nonreportable group are not sorted by type. Understanding how the data is divided is an important first step in developing various ways to exploit and use the information as an aid from a trading standpoint.
The three categories of the COT report are:
1. Large commercial positions (Producer and Consumer Hedgers)
2. Large noncommercial positions (Funds and Large Traders)
3. Nonreported positions (Small Speculators and Small Hedgers)
Of the three, the large commercial category is widely considered to be the most important group. It comprises commercial producers and commercial consumers of a particular commodity. The COT report identifies commercial traders based on two factors: (1) Their position must be large enough to be reported and (2) they must be classified as a hedger. This classification is determined when the account is first established—as either speculative or hedging. This classification also has certain tax benefits or consequences. When opening a hedging account, additional documentation (Forms 102 and 40) may be required by the CFTC to verify a participant is engaged in a business activity hedged by use of the futures or options markets.
Commercial participants are considered the most knowledgeable in each market because their very livelihood depends on their determination of future prices. Although commercial producers and consumers have different reasons for being in the market, they share a common goal: to reduce their risk in the cash market. For producers, this may mean locking in a particular price using futures contracts to reduce the risk of being forced to sell at lower prices in the cash market. Hence, producers will establish a short position in the futures market to reduce or contain their exposure if cash prices fall. Commercial consumers, on the other hand, are concerned about the possibility of rising raw commodity prices and use futures to contain that risk. Thus, the commercial consumer may buy futures contracts to lock in the future price of whatever commodity it needs.
The noncommercial category represents large trader positions and funds that are large enough to be reported, but are not classified as hedgers. Commercial interest can also be included in the noncommercial category, however, because the category is determined solely by account type. There is no rule that states commercials can open hedging accounts but cannot open speculative accounts. Therefore, it is quite possible (and probable), that some speculative accounts are actually controlled by commercial interests.
However, this is likely to be minimal because the tax benefits associated with hedging accounts are an incentive for commercial hedgers to open hedging accounts versus speculative. Most of the time, commercials are going to take advantage of the tax benefits of being classified as a hedger when appropriate (but the CFTC will always have the final say here). Keep in mind that commercials are not required to take advantage of the tax benefits of being classified as a hedger. Furthermore, a large participant could be classified as a commercial hedger in one market and noncommercial in another. Because of these complex issues, it is likely that some level of “cross-contamination” exists between categories. The commercial category, however, widely regarded as the most important category, is likely to contain the least amount of cross-contamination, since it is more difficult to be classified as a hedger and verification is usually required. Thus, I regard the commercial category as the most pure of the three.
Read More : COT And Market Participants
