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Cotton futures bounce back

29
Mar '08
NY futures rebounded this week, with March gaining 188 points to close at 72.90 cents, while December rallied 371 points to close at 82.99 cents.

With the CRB index and nearly all commodities turning back up this week, cotton was able to bounce as well but it did so in rather listless fashion, with volume dropping to a trickle and open interest receding by another 12'000 contracts this week. This kind of action suggests that it was merely a 'dead cat bounce' off of long-term support and not yet the beginning of a new leg up.

One of the main features this week was the widening of the differences between the various months, with the May/Dec spread at one point trading as wide as 1068 points, which represents over 150 points of carry per month. Even today's settlement of 1009 points or 144 points per month is still more than enough carry.

So why is this happening? The main reason is money, or rather a lack thereof. With the certificated stock approaching 900'000 bales this morning, carrying this kind of an inventory will require about 350 million dollars. On top of that a merchant willing to take the certificated stock would have to sell 9'000 July or December futures against it in order to lock in the spread and these short futures would require 32 mio dollars in initial margin requirement plus whatever variation margin may get generated.

A short futures position of that size represents a huge potential liability and therefore, as tempting as this carry trade may seem, the trade may be impossible to pull off from a financial point of view.


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