how I sold cotton at an all-time high
Friends,
In the post If they ban short-selling derivatives become the underlying, I concluded with
If futures are trading at full carry and you think such a ban is possible it’s an asymmetric bet to put on conversions (ie short futures, long stock or for options short combos long stock).
Broadly speaking, the derivatives market becomes the underlying market. When the underlying market becomes encumbered do to technical frictions, derivatives are no longer just “derivatives”. The arbitrage mechanism is severed. The derivatives market becomes the home for price discovery.
I’ve seen this happen throughout my career. Just a few examples in addition to hard or impossible to borrow/short situations:
HYG becoming a liquid referendum on illiquid high-yield bond market
Cotton option synthetics continuing to trade even when the underlying futures are locked limit up (my trading claim to fame is selling the all-time nominal high in cotton in late 2011…it was an option synthetic around $2.25)
When a stock is halted, the premium or discount to any ETFs holding that stock computed using the halted stock’s “last” price before the halt implies the price the stock will open when it resumes trading. These situations were common during the dot-com heyday when stocks would be halted intra-day on pending news announcements.
Today, we are going to cover #2. Along the way I expect several bonus “oh that’s how that works” moments. And call my shot…you will enjoy this one.