New buying lifts NY futures cotton prices to 15-month high

So where do we go from here? The trade is on knife’s edge with its large net short position, hoping for a bearish USDA report on Monday to put a lid on this advance. If that doesn’t happen, the trade will be more or less defenseless against additional spec buying, since we cannot imagine that it will be able to increase its already sizeable short position by a whole lot more.

What worries us in this regard is that there are nearly 48’000 call options open in December 88 to 100 strikes, with the trade being short a lot of them. Over 14’000 of those are in Dec 90 calls and they are getting dangerously close! If the market were to move higher, the trade would have to either buy futures, buy options or roll them higher in order to prevent its short position from getting any bigger.

The strength in spot December has pulled the board further apart, leading to sizeable inversions all the way out to December 2014. While the inversion between December’13 and March’14 makes sense to us given the nearby tightness, we don’t necessarily agree with the 253 points inversion that currently exists between March and July.

This seems to have more to do with the fact that December is pulling up March, while July encounters hedge pressure from producers in Brazil and Australia, than with any fear that cotton will remain in short supply all season long. We therefore expect the March/July inversion to disappear once the current dynamics subside.

Plexus