Cotton Trading Halted for Second Day in a Row

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For the second day in a row, cotton futures & options trading is at a standstill. The press release put out by the Cotton Exchange read as follows:

Pursuant to provisions of Cotton Rule 10.53, trading in Cotton No. 2 options has been halted due to price movement in the contract earlier today.

Under the Rule, both open outcry and electronic trading of the options contracts is halted based upon a determination by the Exchange that the Lead Month futures contract is trading at a synthetic price that is equal to two times the daily price limit then in effect for that futures contract month. The Lead Month is defined as the futures contract month carrying the most open interest and for which the regular options contract is still listed for trading.

So what does this mean for investors? Well,  for the second day in a row cotton is “locked up the limit”, with buyers unable to buy at the limit up price. According to Exchange rules, the price of cotton is allowed to trade up to 5¢/pound above (or below) the previous day’s closing price. If the price moves to this level a circuit breaker is switched and trades above this price level are not permitted until the following trading session. If buy orders overwhelm sell orders the price will “lock” at the limit and if this condition persists, the price will likely “gap up” to a new higher level when buy and sell orders reach a new equilibrium.

What is amazing is this price action is taking place at all new record high prices.

Cotton has been the star commodity performer in 2010 due to solidly bullish supply/demand fundamentals. For years cotton prices languished in the 60 to 70 cent/pound area, with competing crops (such as soybeans in the cotton producing areas of the USA) offering better returns. As a result planted acreage had declined just about every year this decade. However demand, particularly from China, has increased just about every year this decade due to low prices and rising populations. It just would take one supply disruption and cotton prices were set to soar, and the Pakistani floods this year provided that stimulus (Pakistan is the world’s 4th largest cotton producer and the 3rd largest exporter). The result had been more than a doubling of cotton prices from the mid 70 cent level this summer to $1.60 today.

A futures contract is for 50,000 pounds, so every one cent/pound move in price is equivalent to a profit (or loss) of $500 per contract traded. Just the move from $1.00/pound (first hit in September) to $1.50/pound (November) resulted in an incredible $25,000/contract traded (the margin requirement for one contract is currently $5,600).

Will prices continue to soar? Well, in my opinion the market is getting frothy. The supply/demand scenario remains bullish on paper but this could change in 2011. World cotton estimates for next year are, as you may imagine due to high & profitable prices, targeting production increases in major producers (Australia and Brazil in particular). World consumption could suffer a bit from stratospheric prices. I would not try to pick a top today, rather look for a sign of a top on the charts and then use put options to limit our risk once we see that sign.

For retail investors, the easiest way to tap into the cotton surge is the iPath DJ-UBS Cotton Subindex ETN (NYSE: BAL). This cotton exchange traded note is up about +125% so far in 2010. It has been a great year for trading cotton futures, but this ETN has obviously shared in the success as well.

George Kleinman is president of Commodity Resource Corp., a futures advisory and trading firm that assists individual traders as well as corporate hedgers. George has a track record of success in the commodity futures business that spans 30 years. Contact him via e-mail at info@commodity.com.


Article printed from InvestorPlace Media, https://investorplace.com/2010/12/cotton-trading-halted-second-day-in-a-row/.

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