Canola July/Nov spread: Liquidation risks and volatility

A Disorderly Liquidation

In this week’s Spread Trader

Commodity futures contracts follow a predictable lifespan.  

The size of open interest indicates where the contract is in its lifecycle.  Starting at zero, open interest will grow steadily until it peaks when the contract becomes the nearby or front-month contract.  

Approximately a month before the first delivery day, participants will begin liquidating their positions. 

The July canola is at the point of its lifespan when open interest is expected to decline. While open interest has declined to 147k (peaking at 175k), the market faces the prospect of liquidating a relatively large open interest over the next 20 trading days, potentially in a disorderly manner.

Chart 1; July’26/Nov’26 Canola Spread

Chart 1 represents the history of the July’26/Nov’26 canola spread. Given that a large percentage of the open interest of July will be rolled into the Nov, and time is becoming a factor, there are indications that the liquidation could become disorderly and manifested in volatility of the spread.

The July/Nov spread represents a classic example of institutional influences interacting with market forces. The open interest represents approximately 3m tonnes, an amount that makes it impractical for the long to take delivery given institutional regulations outlined in the contract specifications. From the perspective of market forces, the 3m tonne figure represents an amount that the short is unable to deliver against given current ending stock figures. Given recent price action combined with changes to open interest, it appears that the spread will gravitate towards even money or a backwardation orientation for the short to reduce exposure. 

Assuming that the spread moves towards backwardation, it may affect the technical analysis of the November contract, that is, the strength in the spread will result in weakness in the November contract.

Happy Trading

We cover this technical setup and specific price targets in depth in The Spread Trader.

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Trent Klarenbach, BSA AgEc, PAg, publishes the Klarenbach Grain Report,  Klarenbach Special Crops Report and The Spread Trader newsletters.                                                                                                                                                                                                                                                                                                                                                                                                   

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