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NY futures continue to surge this week
Jun '13
The market hasn’t been kind to anyone betting against July, be it outright shorts or those ending up on the wrong side of the July/Dec spread, as the spot month exploded for a gain of over 1200 points in just nine sessions.

July closed at its highest level in nearly three months, just 114 points shy of the March 15 high close of 92.86 cents.

There was a lot going on this week between the Goldman roll, July options expiration and the USDA supply/demand report. The Goldman roll, which concluded today, has provided plenty of liquidity and offered an opportunity for July shorts to exit or roll their positions, although it seems that quite a few traders continued to procrastinate, considering that there were still 58’643 contracts open as of this morning.

Tomorrow’s options expiration will offset a big chunk of this open interest, but we nevertheless feel that there will be some 25’000-30’000 contacts still open at the beginning of next week, with First Notice Day lurking on June 24.

This may not be a big deal in a season with plenty of cotton available, but in a year like this, where we are down to the last million bales of unsold inventory, a short position can turn into a dangerous trap. Although the certified stock keeps increasing and currently amounts to around 560’000 bales, or 5’600 futures contracts, it may not get the shorts out of their predicament.

Even if the current owners were willing to give up the certified stock, new owners may already be waiting in the wings. When the market dropped below 80 cents a couple of weeks ago, it provided a huge incentive for traders to take possession of the certified stock and then either sell it when the market rallied or apply it against existing commitments.

Therefore, if most of the certified stock is already spoken for, it will become very difficult to replace it, since there is simply not much supply available anymore. With little cotton left to back up short bets, the only way out for most traders is to buy back their position. While this was relatively easy to do when the Goldman roll provided liquidity and options offered protection, the shorts may be in for a wild ride next week.

No market maker or trader in his right mind will want to take on a new July short at this point, so the shorts will be mainly at the mercy of existing longs to let them out. However, some of the longs may be intent on taking delivery, while others hang in there for a move to loftier levels. We shall keep a close eye on July open interest for clues regarding a potential short squeeze!

While until a few days ago it could be argued that new crop was simply pulled higher by the strength in the spot month, Wednesday’s USDA report helped to build a bullish case for December beyond the July expiration.

As long as Chinese stocks remain expensive and locked away, the two numbers that matter most in the USDA supply/demand report are a) the ROW (rest-of-the-word) production surplus and b) Chinese imports. The more China imports, the tighter the stocks in the ROW get, which in turn supports world prices.

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