When investors who are used to trading stocks first get into futures, most of what they see makes sense. Open, High, Low, Close, Volume – these are all fairly intuitive. But in the futures trade, there’s another number we sometimes use: open interest (OI). So what’s the lowdown on volume, open interest, and the role that these two stats play in the world of managed futures?
Simply put, volume refers to how many contracts changed hands on a given day. For example, suppose that George buys 20 contracts from John (who is now short 20 contracts to make the other half of the trade). Volume for the day would go up by 20. Now suppose John decides to close out part of his position by buying 10 contracts from our third friend Thomas (who is now short 10 contracts). Volume goes up again, to 30. Simple stuff.
OI is a little more complicated, because it refers to a count of how many contracts are “in play.” In our above example, when George buys 20 contracts from John, OI would be the same as the volume: 20. But, after John buys 10 contracts from Thomas, OI would be unchanged, at 20. This is because the number of open contracts is still 20 – George is long 20, John is short 10, and Thomas is short 10.
To take the example one step further – if John closes out the rest of his position, buying 10 contracts back from George, volume would increase by another 10 – a total of 40 for the day. But OI would decrease from 20 to 10, to reflect the smaller number of active contracts in play (George is long 10, and Thomas is short 10).
So, what does all this mean for CTAs? Volume and OI are important factors in market selection. Volume speaks to liquidity, and OI speaks to how much a given trade will potentially move the markets. If a CTA gets too large for a market – that is, it’s trading so many contracts that it makes up a significant portion of that market’s OI – that can cause a problem. And it’s not just a troublesome for profits – due to the CFTC’s position limits, making huge trades in some markets may break the rules, and bring sanctions for the trader.
As a result, from market to market, you’ll see differences in how big programs can get before they really start to move the market with their trades and either stop accepting new capital or the program starts suffering. For traders in smaller markets, such as agriculture, that level may be as low as $50 or $60 million. Larger markets, like metals, can stomach more – up in the hundreds of millions. Global macro traders (managers trading 30+ world markets) can go even higher, handling a billion or two in AUM without a problem. Currency markets, because they’re so huge, allow FX traders to handle several billions of dollars before they start to be bogged down by size.
For managed futures, size does matter – volume and OI help CTAs determine whether a particular market is right for them. For investors and as a part of our due diligence process, asking the question of “what is the capacity” in any individual managers strategy is a serious question that the most forward-thinking managers are analyzing well in advance of volume or OI becoming an issue for their strategy.