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New Way to Measure Smart Money Hedgers

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While the size of each position is important, the DIRECTION of their positioning is actually more important...

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During parent's weekend in Chapel Hill, something struck me. Maybe it was walking around a college campus that made my brain work better? Who knows? At any rate, I was thinking about what the OVERALL position for hedgers was in the bond market. Last week, I introduced a new concept that combined the COT data for measuring the COMBINED position in the S&P futures for hedgers by netting out the S&P 'big' contract and the adjusted 'e-mini' S&P contract (electronically traded) to come up with the hedgers' overall position in 'big' contract terms. What we found and will show below is that when you combine both contracts, the 'smart money' crowd has been selling this rally. The new data that we received Friday (as of Tuesday's data) shows that they continue to short this rally in near record size. See the chart below. I believed that they would sell the rally hard as we got to the 1370 area in S&P 500 cash and they have.

Overall Hedgers in Net Big S&P 500 Contracts



This is another reason (I have many reasons) that my firm is cautious about stocks. These folks are rarely wrong when making this sort of bet.

I have written much about the hedgers' position in the 10 year note and that although my firm was long the 10 year for investment purposes, we only had a half position or so due to the hedgers being so short the market. Which is what got me thinking, 10's are only part of the market and are very susceptible to mortgage hedging activity. So I began to dig further and look at their position in 2's, 5's, 10's AND 30's. This brings me to my new concept. While the size of each position is important, the DIRECTION of their positioning is actually MORE important to me. In addition, we must consider that each part of the curve has its own duration and hence volatility. You could say that a 100,000 contract position in the 30 year future is nearly 10 times as important as a 100,000 contract position in 2's-this is due to the fact that the long bond's duration is nearly 10 times as long as the 2 year note. So I constructed a custom index that measures a COMBINATION of the net market exposure in the futures contracts of 2's, 5's, 10's and 30's. I will call the combination the overall exposure in units. Below please find charts of each of the components versus the yield of the underlying security and at the end, the overall position.

A couple of things to note. First, the bets they make are usually correct when made in size-in other words, they tend to 'take the other side of the momentum trade' and buy dips and short rallies. Second, the sizes of the bets are getting larger as the marketplace for futures grows. This is due, I suspect, to the tons of money floating around the system, courtesy of central bankers around the globe. It is also, I imagine, due to the size of the hedge fund community. Hedgers, many times, will take the other side of the hedge fund's momentum trades. So it comes as no surprise that their positions at present are opposite in terms of market direction. Anyway, here are the charts.

Two Year Note Versus Hedgers



Five Year Note Versus Hedgers



10 Year Note Versus Hedgers



Long Bond Versus Hedgers



Overall Net (Duration Adjusted) Position Versus 10 Year Treasury Yield



I live by a couple of important trading and investment principles.

  • 'Buy low, sell high' is one.
  • 'Buy from the fearful and sell to the greedy' is another.
  • A third is 'buy when you can, not when you have to.'


I think following these three principles is key to generating excellent returns over time and the commercial trading accounts seem to live by them too. I guess that is why they call them 'smart money.' And at present, they seem to be shorting the stock market in near-record size and reducing their short-side bet in the bond market quickly. While not yet long the market (as of Tuesday anyway), they are definitely making a move away from being short.

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Position in S&P 500, 2 year, 5 year and 10 year Treasuries

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