A 101 on the big Traders in Financial Futures (TFF) imbalances (by Andy Constan)
A 101 on the big Traders in Financial Futures (TFF) imbalances (by Andy Constan)

A 101 on the big Traders in Financial Futures (TFF) imbalances (by Andy Constan)

Why this isn’t a contra signal:

Why this is a good piece of evidence and helped me call the rally in July

And why this is nothing at all

This data is from the CFTC and is called Traders in Financial Futures (TFF) it is release weekly on Friday afternoon based on positions on Tuesday close. Every large trader needs to report and choose what they are for the report into 4 categories of which the three I show are the meaningful ones:

Chart 1 are Hedge funds
Chart 2 are unlevered funds like pension and mutual funds
Chart 3 are dealers.

This data is about futures and futures options only. It has no information about SPY or long cash index baskets or individual portfolios or stock or index Options. This is a partial picture of exposures.

So let’s set up a ground rule. Let’s assume within each category of report there are those that are long, those that are short and those that are flat market risk. Also let’s assume for now there’s everyone else in the market that doesn’t trade futures at all and could be either one of the three categories or some other type of investor say for example retail or an institution who only trades cash products. Ok got it? If not reread the setup. It’s pretty comprehensive but get comfortable.

Currently hedge funds net have expressed a large short position. Not large in a historical sense but large vs lately. Zooming out from chart 1. Not big short vs history

Nonetheless a big short and growing as the market rallies. Will these funds be forced to cover? Well that’s where the story gets complicated. Every single future that the hedge funds are short are longs from one of the other two groups. Asset managers are long but as in chart they have been selling. Dealers are really long.

Let’s examine that dealers are intermediaries. They don’t want directional risk. But now they are long a ton of futures. What do they do when they buy a future? Typically they buy what a client who doesn’t use futures has bought an index product. Options or ETF’s in particular. Let’s keep it simple and just use and etf. An institutional client asks a dealer for a block offering on SPY. The dealer gives a price and is lifted. They immediately go to the most liquid market to cover their market exposure. They buy futures. A hedge fund sells and the TFF report shows that dealer long and hedge fund short. BUT the dealer actually has no net exposure to the market. AND someone else has just gotten LONG SPY which the TFF ignores. This is why the hedge fund chart is a lousy indicator.

What matters is not that the hedge fund is short or that someone else is long. What matters is who blinks. Who is forced out. The professional hedge fund or the other side. The raw numbers are confusing as well because the other side who bought the ETF could be a hedge fund themselves and the blinking game is between two hedge funds. The TFF report won’t see that. Perhaps the size might be useful to some in that big net positions likely me lots of “Chicken” being played. But you have to know more about who the risk takers are and what do they do Under stress. I see no use in the TFF Hedge Fund positioning stand alone for a contra signal or for that matter a trend signal. In chart 3 the dealer positioning means very little at all. These guys don’t take market risk and the unwind of a long like today happens when an end client sells his ETF. His stress may matter but the dealer is chill.

So let’s talk about chart 2 and what it means and why it was useful to me in calling the bounce in July. This goes to understanding then behavior of a pool of investors through time and using the data on the chart to confirm that behavior and most recently to anticipate the path of future behavior. Remember Flow is only useful for trading if you know a trader is going to move markets before they act. This data is 3 days old when it is reported so it’s useless except to predict future reports.

Who are these unlevered funds and why are they using futures to begin with given they are unlevered. This tale goes back as far as the Brady commission which I served on in 1987. See this story (Brady commission). Given my origin story told above I have spent my career understanding how investors invest at very mechanical level. Pension funds, insurance companies, and mutual funds all use futures for the same 2 basic reasons. 1. To get market exposure or cut market exposure based on inflows and outflows in a timely and liquid way until they can swap out of the futures and get invested in their desired exposure to individual stocks. 2. To rapidly add or reduce risk for risk management and performance purposes.

Most unlevered funds keep a portion of their AUM long futures for cash management reasons. Notice in the whole data series they are never net short

Does anyone start to see my signal? Well let’s go back to 1987 and portfolio insurance. Even today that widely discredited strategy which caused the crash is used every day. As markets fall unlevered funds want to derisk to minimize drawdown. They do it by selling some of their long futures position. When the market rallies they buy it back. The 1H of 2022 was a great long only deleveraging. End investors didn’t really redeem. These vehicles are part of investors long term savings. But the PM’s at the funds use PI for outperformance they delevered 150BN in 1H2022. My knowledge of the mechanics and use of Portfolio insurance is confirmed by the data which is coincident with the move in markets. BUT they only delver based on their risk management estimate of risk. I have a model for now they behave and by 6/28 they were almost done selling and would turn buyer on a rally. That data was useful.

The hedge fund short may be useful if these guys blink before the people who bought SPY from the dealer who bought the futures from the hedge fund. But that’s not at all clear who will win.

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