CME Slaps Investors Again

Jim Brown
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The Chicago Mercantile Exchange (CME) is on a mission. They single handedly cost investors tens of billions of dollars last week by raising margins on silver futures five times in a two-week period. Prices plunged -27%. The CME is now taking aim at oil traders.

Late Monday the CME raised the margin rates on crude oil futures by 25% from $6,750 per contract to $8,438. This is the second margin hike on crude in the last two months. Back in March they increased margins from $6,075 to $6,750. The margin hike on Monday affected both WTI and Brent contracts. The margin rates become effective at the end of trading on Tuesday.

That means anyone holding crude futures contracts has the regular session on Tuesday to scale down their positions to a level that won't create a margin call when the new margins come into effect.

For instance, if a macro fund wanted to buy 200 contracts of crude futures their margin required would change at the close on Tuesday from $1,350,000 to $1,687,600. That is the initial margin to make the purchase. The maintenance margin to continue holding the contracts after 24 hours would be $1,250,000. ($6,250 each, up from $5,000) Basically the initial margin assumes the buyer might trade it and the maintenance margin assumes you are going to hold the position for several days.

The CME said it was not due to the price or oil but the volatility surrounding oil. Last week WTI crude declined from $114 to $97 and then rebounded today to just over $103. After the new margin requirements were announced prices declined to $100 on the news.

CME Clearing president Taylor wrote in her blog post on margins, "Margins are set as part of the neutral risk management services we provide. They aren't a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another. Rather, margin is one of many risk management tools that help us assess overall portfolio risk to protect market participants and the market as a whole."

Personally I think that is a load of crap. The conspiracy theorist in me wants to believe that the White House saw the dramatic impact on silver prices last week as a result of the margin hikes and "suggested" to the CME to do the same thing with oil. After all what could be better for an election cycle than a crash of oil and gas prices. Obviously that is sheer speculation on my part.

In reality the CME has changed margin on some of its products on 58 days so far in 2011. Now that is what I call volatility. When you realize that every margin change forces some percentage of traders out of their existing positions that number of changes seems dramatically unreasonable. How can an investor make a rational plan on trading/investing in a particular commodity when the rules can change on a CME whim?

Wouldn't it make more sense to change margins one day a month, say the first Monday of the month? This would remove some of the volatility the CME appears to be so worried about and not have traders waking up every morning and rushing to the CME site to see if the margins on the positions they are holding had changed. The CME should have to notify traders two weeks in advance of the monthly margin change day. That avoids the sudden panic of a 24-48 hour surprise notice like we saw from them last week.

I would suspect oil prices will decline on Tuesday. I doubt many traders are so glad margins rose they are going to rush out and go long at the open. Those who are margined to their limits will be forced to close positions to avoid a margin call. Unless some other news event appears to push crude higher I think the next two days could be negative.

Long term I don't think it will have a material impact on oil prices. The greater impact on prices is obviously supply and demand. Since supply is shrinking and demand is increasing we are going to have increasing volatility built into the price for years to come.

Jim Brown

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