What Is a Sold-out Market?
A sold-out market is a scenario wherein all, or nearly all, of the remaining investors, have sold or closed out their positions. Sold-out markets, as a result, contain very few traders left to sell anything. A sold-out market can occur for various reasons, such as limited choices or poor liquidity, meaning there aren't enough investors in the marketplace.
- A sold-out market is a scenario wherein all, or nearly all, of the remaining investors have sold or closed out their positions.
- A sold-out market can occur due to poor liquidity, meaning there aren't enough investors in the marketplace.
- Typically, a sold-out market refers to the unavailability of a forward or futures contract in a particular commodity or maturity date.
Understanding Sold-out Markets
A sold-out market occurs when most of a contract's long positions have already been sold or liquidated, and thus produces an increasingly short supply. Sold-out markets usually occur in the forward markets or in assets based on industries that have limited liquidity. In the worst case, once a market is sold-out, no more contracts are available for sale, and trading grinds to a halt.
Commodities that trade as futures contracts allow investors to hedge or lock in the price of a commodity to be delivered on a preset date outlined in the contract. Commodities traded as futures can include silver, gold, wheat, and corn. Futures trade on a futures exchange and are standardized, which means, in part, that the contracts have specific maturity dates throughout the year.
In other words, the maturity dates for futures cannot be customized to a company's or an investor's specific needs. If a particular commodity is thinly traded, sometimes the commodity's futures contract can be unavailable for a particular maturity date because there aren't any offerings.
A sold-out market can also occur in a currency pair, such as the euro versus the U.S. dollar (EUR/USD) after a downward movement. If the exchange rate is falling, meaning there are a lot of sellers in the market, at some point a sold-out or exhausted market can occur. If most long positions have been sold in a currency pair, it can indicate that the forex rate for that currency pair may soon correct and should rise. A sold-out market can occur in a currency that is thinly traded or at a time of the day or week when the markets are on holiday or are near their closing time.
Sold-out Market and Exchanges
A sold-out market is a relatively uncommon condition on modern exchanges, such as the New York Stock Exchange (NYSE). Typically, there is enough liquidity to facilitate trades since major exchanges often have an abundance of liquidity providers who will make an offer to any buyer in the market. These exchanges make use of a market maker or specialist mechanism.
Specialists maintain an inventory of various stocks, in which they post the buy and sell prices, manage orders, and execute trades. If there is an imbalance in the market in which the market doesn't have the adequate buyers or sellers to facilitate trades, specialists step in and use their inventory. As a result, the liquidity is enhanced since investors can buy or sell their security when they want to without delay.
However, in other markets such as the over the counter (OTC) markets, buyers can sometimes struggle to find sellers and vice versa. Securities that trade over-the-counter are not listed on a formal exchange such as the NYSE. Instead, the OTC markets use a broker-dealer network that trade via an electronic system called the over the counter bulletin board (OTCBB).
Many companies listed on the OTC market are small companies that have thin liquidity, meaning there's a low volume of trades being dealt on a daily basis. As a result of the low trading volume, some securities may not have available sellers or buyers of a particular security.
Example of a Sold-out Market
Let's say that a yogurt producer wants to hedge their price risk using forward contracts, which allow a price to be locked in for a specific date in the future. The yogurt forward market trades over the counter.
The producer wants to lock in their selling price of the yogurt for three months in the future because that's when they'll sell their goods. Even if yogurt prices decline to a price lower than the forward price in the next three months, the producer will get paid the three-month forward price.
The local supermarket chain often takes the other side of the trade to hedge changes in the price of yogurt. In other words, the supermarket locks in their price to buy yogurt from the producer because they want to fix their costs for the next three months. No matter how much yogurt prices might rise in the next three months, the supermarket will be able to buy the yogurt from the producer at the forward price.
Recently, there have been several new yogurt producers that have entered the market who also seek to hedge their risk exposure. However, the supermarket chain has already hedged all of its risk and is unwilling to sell any more forward contracts, which would actually increase their own risk exposures since they are already fully hedged. As a result, these new yogurt producers confront a sold-out market in yogurt forwards and are unable to hedge.