Seasonal Cotton Traders Big Winners

Mar. 9.10 | About: iPath Dow (BAL)

By Brad Zigler

Normally at this time of year, seasonal cotton traders would be looking forward to peeling off a monthlong position in the July delivery that's proved to be a fairly reliable winner. A purchase in the second week of February ordinarily—that is, 80 percent of the time—turns a $1,150-per-contract profit. Or rather, turned a profit.

Last year, amid glut and wobbly consumer demand, the trade would have actually produced a $1,725 loss.

But cotton's back now. In a big way. Since Feb. 16, old crop cotton's climbed more than 6 cents a pound, which doesn't sound like much ‘til you consider a contract calls for delivery of 50,000 pounds. That translates to a better-than-$3,000 gain, or a 144-percent return on margin.

ICE/NYBOT Cotton (Jul. '10)

ICE/NYBOT Cotton (Jul. ’10)

Right now, cotton's consolidating after running up toward two-year highs, while traders await a fresh round of government supply and demand estimates. Retailers seem to be restocking textile inventories in anticipation of a resurgent consumer appetite for new duds.

The buzz among traders is that the U.S. Department of Agriculture will lower its forecast for old crop production based upon recent declines in ginnings.

That's caused prices to congest between 82 and 83 cents per pound ahead of the Wednesday USDA report. But look at the shape of the congestion area. The lower highs and higher lows traced by the stalled market indicate the degree of tension being built up. It's also a likely indicator—let's put the odds at 75 percent—of a bullish breakout. Given recent price dynamics, in fact, a spike to the 86-cent level seems likely.

Normally, seasonal traders would be looking for the exits on March 10, but this may be a year when some decide to stick around, hoping for another 3-cent ($1,500-per-contract) pop.

Futures traders are looking at an incremental reward-to-risk proposition of about 0.7-to-1 at current margin rates. For an unleveraged position in the iPath Dow Jones-UBS Cotton Total Return Subindex ETN (NYSE Arca: BAL), a potential breakout to the $41.80 level would produce a $2.50-per-share gain.