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  • QA 115
    Question:
    What is the purpose of 'stopping tenders' on the futures market?
    Background:
    The London robusta market has been behaving strangely of late with the nearby positions priced higher than the distant positions. Now we read about 'tenders being stopped' and we wonder what this means? Are roasters now buying from the futures market?
    Asked by:
    Exporter - Vietnam
     
    Answer:

    If the holder of a long* spot futures contract decides to take delivery, rather than enter into an offsetting sale, then he or she is in fact forcing the original seller to tender physical coffee instead. This practice is known as 'stopping'  - the receiver holds on to the coffee and does not necessarily re-tender it when the next position becomes the spot month. 

    Please see QA 109 for an explanation of 'backwardation' on a futures market, i.e. when prices for nearby delivery are higher than those for distant delivery positions. Usually because of a lack of spot coffee versus much better availability of forward shipments.

    This price trend can gather momentum through the 'stopping' of tenders. That is, one or more holders of futures contracts for spot delivery decide to take delivery of physical coffee rather than enter into off-setting sales, or re-tendering the coffee when the next spot position comes around. This has the effect of increasing demand for spot or nearby stocks of tenderable coffee, thus placing yet more pressure on prices for such spot or nearby coffee. 

    In some situations it does happen that roasters take delivery from the futures market, but this is the exception rather than the norm. Instead it is more common that certain parties may see a technical opportunity to make profits by taking delivery and 'stopping' or holding these stocks until it becomes profitable for them to release them back into the futures market. Not only is this risky and speculative, but it also requires considerable financial resources to hold such stocks. The market therefore has to judge whether these stocks are in 'strong hands' that are able to hold on or, alternatively, that the 'stoppers' may be forced to liquidate relatively soon. When large-scale and unexplained 'stopping' happens then the market sometimes speaks of a 'squeeze' on the nearby position.

    The ever-present risk is of course that the holders of 'stopped' stocks decide, or are forced to liquidate them and spot/nearby prices collapse. This risk increases the longer a stopping operation continues whilst holders of physical stocks in producing countries in the meantime rush to ship and tender these against an over-priced futures position…And furthermore, regulators frown upon unusual occurrences and will review each event, with some exchange managers having the authority to liquidate any large player who is judged to be 'pushing prices'. 

    QA 109 discusses some of the physical and logistical impact backwardation can have on producers and exporters. But there is also another aspect to this. If some roasters are caught out by such a situation they may look for alternatives - in this case secondary, cheaper arabicas for example. This may then have the effect of also raising prices for spot or nearby delivery of this kind of (replacement) coffee.

    See Chapter 08 Futures Markets and 09 Hedging and Other Operations for more on futures trading generally.

    * See Section 10.07.01 for a brief description of different trade terms such as 'long' for example.

    Posted 09 September 2006

    Related chapter(s):
    Related Q & A:
    QA 051, QA 054, QA 092, QA 109