Ongoing short-covering of financial positions gave another major boost to European CIF ARA thermal coal futures at the start of the trading week, with contracts gaining over $3 across the curve during a single session Monday.
Numerous market sources said that, once again, a major counterparty was making significant mark-to-market losses after writing call options on the Q4-16 and year-ahead Cal-17 contracts, with strike prices for both short call options ranging between $50-$60/mt.
With both the Q4-16 and Cal-17 contract prices now trading above $50/mt for 18 and 17 trading days respectively, the counterparty in question had begun delta-hedging in a bid to mitigate further losses, according to numerous sources.
This strategy saw the company buying outright futures on both contracts -- executing trades through numerous banks -- reducing its exposure to price movements and sustaining the premium on its options.
Subsequently, the value of both contracts spiked Monday, with the Cal-17 marking the largest day-on-day gain -- at 6.1% -- seen in seven years, pushing the value up to $59/mt. This is a level not seen since July 2015, according to S&P Global Platts historical data.
Even larger day-on-day gains were seen on the more liquid Q4-16 contract, which moved up 7.3% Monday to $60.50/mt.
Given that contracts had moved so aggressively, several sources said that other counterparties who were short Q4-16 and Cal-17 contracts would have likely been stopped out of positions before having to buy back contracts in order to re-enter the market, further fueling the buying spree.
MARGINS SURGE
"There's not a single outside influencer in this recent upswing; it's all based on the options positions," a London-based trader noted of the trend. "Since the last push on prices [when the Cal-17 contract peaked at $54.40/mt June 07] producer currencies haven't moved much and Brent [crude oil] has been pretty steady. There's no fundamental reason behind the move, but if buyers are covering short positions, then this could run and run until the options expiry."
This was echoed by several sources, who said that although Brent had rallied slightly, this alone could not account for the magnitude of Monday's movements.
Front-month ICE Brent crude oil futures gained just over 2% from Friday to Monday, while the dollar index closed just over half a percentage point down over the same period, making dollar-denominated coal somewhat cheaper for buyers in Europe.
"The margins are fabulous. If you're a producer, you're very happy right now, even if you're making losses on your financial position," one trader noted.
This was reflected in share prices, with Switzerland-based Glencore and US Anglo American gaining nearly 5% and 4% in value respectively on Monday from Friday's close, largely on the back of rallies in coal pricing, adding up to $600 million to their market value.
However, the spike promoted physical sellers to enter the CIF ARA market, looking to lock in physical tons for delivery in Q4 and Cal-17 at prices close to $60/mt. Subsequently, this put a cap on derivative prices by Tuesday, erasing most of Monday's gains, before buying started again in earnest Wednesday.
"This is an important price action," a London-based trader with a hedge fund explained. "It illustrates how the market is positioned."
A SUSTAINED TREND
With numerous market participants attributing the latest rally in prices to positioning, there was growing concern that the derivatives, and subsequently physical, markets were breaking with fundamentals.
Recent data released by both the ICE futures platform and the London Energy Brokers' Association highlighted this trend, showing a marked shift towards options trading and bilateral deals during May.
Although the total volume of coal traded and cleared through the ICE platform for ARA delivery had slipped 9% month on month to 163 million mt during May, the proportion of options trading was over 50%, at 87 million mt; the highest level on record since March 2014, according to Platts data.
In addition, LEBA data showed that brokers' bilateral share of the coal market had spiked to 12% in May, the largest proportion of uncleared volume on record since August 2014 according to Platts historical data.
"The market is more volatile and that looks likely to continue, influencing trading strategies. If you want to buy or sell volatility, you buy and sell options," a trader explained.