Last week, US Federal Reserve Chair Jerome Powell reaffirmed the Fed’s commitment to reducing inflation no matter the short-term cost to the economy. More aggressive interest rake hikes now appear to be on the table and unsurprisingly stocks sold off sharply in response. The S&P 500 Index erased August’s gains and finished the month down over 4%.
S&P 500 Index (SPX) 6-months
Large moves like what we have recently seen in stocks have become more and more common in various global markets. Increased volatility and subsequently higher margin requirements have significantly impacted trading. Consequently, some markets have become inaccessible for investors due to risk constraints.
Last week, a commodity hedge fund manager well known for his bullish calls said on Twitter that the crude oil market is broken as futures now can move $10 a barrel “for no apparent reason.” Exchanges have increased margin requirements to trade energy futures as volatility has spiked (some traded with negative prices after March 2020 which had never been seen before). Crude Oil’s open interest levels (the number of contracts outstanding) are at a seven-year low, which makes bigger moves more frequent. Crude oil has erased over 20% gains in the past three months amid fear of global slowdown and despite structural low supplies.
Crude Oil (CL) 6-months
Another example in the current environment is UK Natural Gas. This product is traded in minimum lots of 5 contracts and each contract is worth £200,000. In contrast, US Crude Oil can be traded in single contract worth $86,000. The minimum position size in UK Nat Gas is currently £1,000,000 with moves of over 25% in a single day as seen in the chart below! With higher margin requirements and the possibility of a 25%+ move against you, you better have a strong risk control process and deep pockets.
UK Natural Gas (FN) 6-months
Volatility in the markets is here to stay and a well-defined investment strategy with sound risk controls becomes crucial to survival let alone success in the current environment.