Determinants of Trader Profits in Futures Markets

Using a unique proprietary data set of positions held by all large traders in the crude oil, gasoline, and heating oil futures markets, we use actual trader profits to test the predictions of various commodity futures pricing models. We find statistically and economically significant evidence that: (a) mean hedger profits are negative while speculator profits are positive, which is consistent with the risk premium hypothesis, (b) traders (whether speculators or hedgers) who hold long (short) positions when likely hedgers in aggregate are net short (long) have higher profits than traders whose net positions are aligned with likely hedgers, which is consistent with the hedging pressure hypothesis, and (c) profits on long positions vary inversely with inventories and directly with price volatility, which is consistent with the modern theory of storage. We establish these associations while controlling for macroeconomic risk factors that potentially affect futures returns and for trader characteristics. Our results indicate also that the momentum in commodity futures markets may be due largely to hedging pressure