An exchange or regulator may restrict the number of shares or derivative contracts that a trader, or any group of traders and investors, can possess. Position limitations are placed in place to prevent anybody from utilizing their ownership control, either directly or via derivatives, to exert unilateral control over a market and its pricing.
Knowing Your Positional Limits
Most individual traders would never have to worry about exceeding position limits, but they serve a vital role in the derivatives market. In most cases, the position limits are too high for a single trader to hit them. A positive side effect of these constraints is that they keep the financial markets more stable by prohibiting huge investors or groups of investors from manipulating market prices and exploiting derivatives to gain a monopolistic position.
For example, huge investors, or funds, can establish a controlling stake in particular stocks or commodities without owning the physical assets themselves by purchasing call options or futures contracts. In big enough numbers, these investments can shift the balance of power in corporate voting blocks or commodity markets, resulting in greater market volatility.
Procedure for Determining Position Limits
On a contract-by-contract basis, position restrictions are set in stone. One option contract that controls 100 futures contracts is treated the same as a trader who owns 100 futures contracts on their own. A trader's ability to influence the market is at the heart of this exercise in power. Intraday position limitations are enforced. A trader's total exposure or holdings after the trading day are subject to various financial laws, although position limits apply throughout the day. If traders exceed the position limit throughout the day, they violate it.
Possible Restriction In The Position
Market manipulation and price distortions are prevented by speculators who take massive holdings beyond their business needs while allowing bona fide hedging actions to proceed. Regulations have been proposed by the CFTC to clarify permissible trading activities, set position limitations for new commodity interests, and revise aggregation criteria under 17 CFR 150.4 during the last decade.
Regarding finalizing the aggregation rules, the CFTC has had to deal with issues that have emerged through administrative relief. Establishing sensible position limitations is something the CFTC has struggled with for quite some time. A challenging task has thus been set before it: correcting the problems caused by numerous policies finalized, withdrawn, or proposed while proposing newer or alternative exclusions to encourage legitimate hedging.
Previous Position Limit Proposal
Position limit restrictions and aggregate requirements for speculative positions in some physical commodities contracts and their economic counterparts have been proposed, changed, and proposed again by the CFTC for about a decade. Only a few agricultural goods are subject to the CFTC's existing position restrictions, which prohibit market participants from exceeding such limits absent the use of hedging exemptions specified by the Commission or authorized by an exchange. A vital part of the Commission's mandate is developing reasonable speculative position limits and exclusions. Position limitations at the exchanges apply to a considerably broader range of items.
New Position Limit Regulations in the Wake of Dodd-Frank
After the financial crisis, Congress entrusted the CFTC with preventing disruptive trading behaviors, and position limit breaches in commodities and associated financial instruments. According to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the CFTC must prohibit swaps which are "economically comparable" to certain commodities in order to avoid excessive speculation.
Following the CFTC's reaction, the "2011 Final Rule" set restrictions on speculative positions in 28 physical commodities in the form of futures, ETPs, and swaps. As a result of the 2011 Final Rule, massive speculative holdings on futures and swaps markets were supposed to be limited to reduce volatility.
Proposed 2013 Speculative Position Limit
Following a judicial setback, proposals were made to alter position limitations on speculative positions in 28 physical commodities contracts. Additional exclusions under Regulation 150.4, such as the bona genuine hedging exemption and revised reporting requirements for organizations claiming exemptions, were included in the 2013 Position Limit Proposal.
The proposal altered speculative positions in all-month, spot-month, and non-spot-month positions. To avoid excessive speculation, the CFTC reviewed public views, changed definitions, and integrated comprehensive factual research of the requirement of speculative position restrictions.
Considerations
Margin requirements can also be changed to minimize their impact on market pricing. An individual investor or group of investors may be unaffected. Still, the capital reserves required to keep the same number of positions will grow, making it more expensive to corner the market. Increasing margin needs For example, in 2011, the margin limits for gold and silver were modified, resulting in the price of both precious metals plummeting following substantial rises.
