Market Liquidity Makes All the Difference

Market Liquidity Makes All the Difference

Today’s market activity in Cotton shows how important it is to trade in liquid markets. If you were fortunate enough to be long Cotton in the last several months then you have some very nice gains. Recently, however, the market volatility in Cotton has made holding a position quite difficult. For example, Cotton has settled either Limit Up or Limit Down 5 times in the last 15 trading days. Each time it closes at the limit, market liquidity is reduced to traders who are willing to participate in the options markets. This substantially reduces the number of participants and incurs a decrease in liquidity. Markets with Trading Limits include the Grains, Orange Juice and to a lesser extent, Stock Index Futures.

Today’s trading in Cotton followed yesterday’s synthetic settlement price of $1.1887. That price, the price at which all Clearing of Transactions took place, was 4 cents beyond the limit price of $1.1487. Today, in contrast, Cotton had a trading high of $1.1980 and a synthetic settlement price of $1.0950 which was 37 tics below the Limit Down price. One could argue that Trading Limits on Exchange Traded Products maintain order in the market, but as exemplified by the tremendous swings in the Cotton market, Limits only seem to reduce liquidity and cause the participants to be lured into trading vacuums.

Trading volatile markets can be profitable but it is difficult to manage the risk of the position. It is always essential to define the risk/reward of any transaction. When markets are volatile, one is forced to increase the risk one is willing to take in order to potentially reap the benefits of a continued market move. Options strategies can provide a limited risk methodology for establishing positions in markets that are extremely volatile. By initiating these positions one can participate in volatile but trending markets with a clearly defined risk/reward position. Here are a couple of suggestions:

To Get Long Cotton, one should consider the following position using today’s settlement prices: Buy the December 115/120 Call Spread for 116 points while Selling the 104/99 Put Spread for 148 points. The call and put spread are equidistant from the synthetic settlement of $1.0950. This is an opportunity to get Long Cotton with a limited risk position and a 32 tic credit.

To Get Short, one might consider a Fence with unlimited risk because you’ll sell the 130 Call which settled at 115 points and Purchase the 97 Put for 113 tics. Notice the comparatively expensively priced call. The Short Call is 20.50 Cents from settlement while the 97 Put is only 12.50 Cents away. Keep in mind that because of the short call the risk is unlimited.

There are always interesting options positions available for any market bias. The tremendous volatility in the Cotton market provides significant opportunities for traders with patience. Feel free to contact me at 212-383-9453 to discuss a variety of options trading strategies whether pertaining to Cotton or other markets.

Comments

[schaafgregg]

So are you a broker of options on commodities?

Is there some kind of restriction on  posting here for commercial purposes? 

Can you refer me to a website or several websites for brokers of options on commodities which are reputable or can one deal directly with the marketmakers in some fashion?  I have futures accounts with thinkorswim and Interactive Brokers.