Today’s price action was considered by many to be an inside trading day technically, with most of the volume in NY Cotton futures once again focused upon spread relationships. These spreads are basically the price differentials between futures months and they have generated a majority of the volume traded recently. This volume results not only as the spreads themselves trade, but also as locals trade positions in the outright months, as a form of arbitrage.
When a spread transaction occurs, it involves the purchase of one month and the simultaneous sale of another. Many traders seek to profit on the trading these differences rather than trading outright positions. There are options available on most spreads, but unfortunately since they expire along with the options in the front leg, or month, there has so far been only light interest in the options on spreads.
During the past few weeks there has been the obvious movement of positions being held in the May contract into the July contract. This movement typically takes place as First notice Day approaches, since getting involved in delivery is not the desire of anyone not in the actual physical business. Just last week the July contract assumed the leadership role as the most active contract month, when it began having a larger number of contracts in open interest. The action in spreads, as we have seen with the May/July spread, tends to narrow the differences as short positions get moved from May into July, as the May’s are purchased and July’s simultaneously sold. The opposite is true when long positions are rolled forward. Since different positions tend to get moved at different times, we’ve seen the timing of these rolls as longs and then shorts get moved from one month to another have much to do with the direction of these differences.
Yet, there is also a great deal of interest placed upon these relationships as the spreads also tend to move with the direction of the underlying price. As a rule of thumb, when prices go lower these spreads tend to widen, and as prices move higher they tend to narrow. There are many exceptions to that routine, but it is widely accepted in practice. There are also many who focus primarily upon trading spreads and do very little trading in outright months. A large portion of this style of trader is comprised of the local floor population. There are others too who are located away from the trading floor that trade the relationships between months. Merchants and Producers are members of the trade that are frequent participants. There are also large speculators willing to take positions in spreads seeking to profit from a move in the relationship between months.
In today’s market there was again quite a bit of focus upon these relationships. The May/July spread opened around 165/170 and widened quickly to 175. From there it narrowed substantially over the course of the day. First coming in to 135 and then widening back out to 160, before narrowing in again to 150. The May/December, which traded yesterday as wide as 640, today traded 620 and 630 then came in when big volume changed hands at 600 and then later 575. This is a larger move than what transpired in the underlying.
The action in these spreads seemed to be influenced today largely by local traders who have been considering that difference should narrow somewhat now that many of the long positions have been moved by index funds. Of course there are obviously large short positions that have been moved too and probably still positions held by both longs and shorts that may still get moved, but the attitude among floor traders is that these differences should narrow somewhat. That may have been part of the reason pressure was evident as differences did narrow. There was perhaps some trade selling above 165 and 170 early on in the K/N, but for the most part the trade seemed to not participate much in K/N and instead focused some interest in buying the K/Z.
It seemed that the buyers of these spreads on the day were primarily specs, although one particular fund was thought to have sold around 1,000 of the K/Z’s today, just as they have done now for the last few days. Members of the trade certainly played a role too, but most of the action in the spreads seemed dominated by locals and specs. Estimated volume for spreads today were 10,000 in the K/N, 2,000 in the K/Z and 1,000 in the N/Z.
Tomorrow’s Spec/Hedge numbers are anticipated to show the results of the speculative selling we have been experiencing this past week. It is widely accepted that this week’s number should show the Net Spec position as being short between 7.0 and 8.0%. There are some who believe that this number may be closer to 10.0%, but it is also widely acknowledged that until this number is over 15.00% short, it’s doubtful that any significant short covering rally can come about. There was a time when this figure was more influential than it has been recently. That likely stems from the fact that the number has been pretty neutral of late.
Option transactions had a somewhat bearish tone early on with another 150 of the Z 59/52 put/Z 63 call three way spreads trading early for 45-50 point debit, these traded yesterday and are thought to be as a hedge against cotton released from the loan. There was also some selling in July calls with 100 N 57 calls sold early for 105, then later 200 N 56’s were sold between 135-130, and finally 125 N 59’s at 60. Also early 100 N 56 puts were sold for 295. However, the featured trades involved the N/Z 62 call spreads which traded 250 lots , once in the middle of the session and again later on nearer the close. Those changed hands at a 240 point credit both times and the prices used were 265 and 25. There was some late buying of Z 62 calls at 268 and Z 65 calls for 185 and 184. Perhaps 200 of each of those went.
Monday, the 24th will is First Notice Day for the May contract, so don’t be surprised if May loses another 7,500 from today’s action.
By Jurgens Bauer, VP