Futures trading activity and stock price volatility: some extensions

An earlier investigation by Bessembinder and Seguin employed open interest data to demonstrate that heavy (unexpected) trading activity in stock index futures is destabilizing. This article re-examines the issue in the framework of the commitments of four groups of traders in the S&P 500 index futures market: hedgers (institutional traders), large speculators, small traders and spreaders. Finding that surges in institutional commitments in index futures are followed by increased levels of price variability. The results are not conclusive on whether portfolio insurance strategies contribute to this relationship. Moreover, there is no evidence that the participation of other futures traders, notably large speculators and small traders, is destabilizing. An implication is that the current margins structure that favours institutional traders is ill-suited to the goal of volatility-control. The release of the commitment of trader data which provides open interest information on an ex post basis is found to have no impact on stock market volatility. Thus, the positive relationship between surges in institutional futures activity and volatility seems to stem from trading mechanisms, rather than from the formal disclosure of commitment of traders.