The week ending March 9 saw nearby ICE cotton futures rally strongly above 86 cents, drop precipitously, then more deliberately march back towards 85 cents by Friday. Trading this week continued in above average volume. Fundamental news included continued strong export sales, as well as very strong export shipments. An expected continuation of strong export shipments was cited by USDA as the rationale for raising forecasted 2017/18 U.S. exports in the March WASDE (released Thursday). The implications of that report were generally bullish for U.S. old crop cotton prices — or put another way, it was an improvement on a long term bearish outlook.
May’18 cotton on the ICE settled on Friday March 9 at 84.52 cents per pound. The Jul’18 contract settled 33 points lower. This inverted futures spread obviously does not covering the cost of storing cotton, e.g., Jul’18 would need to exceed May’18 by at least 150 points. There remains no strong market signal to store 2017 bales in hopes of higher prices, except for contingency purposes (what an egghead economist would call “convenience yield”).
Both old crop contracts remained inverted above Dec’18 which settled at 78.72 cents per pound on Friday March 9. Chinese and world cotton prices futures were mixed this week.
A sample of option prices on ICE cotton futures saw some changes from the previous week because of the rise in the underlying futures. On Thursday March 8, in-the-money 73 call options on Jul’18 ICE futures were worth 11.91 cents per pound (up two cents from the previous week). Lesser-in-the-money 79 calls on Jul’18 were worth 7.01 cents (up 1.8 cents, week over week). A near-the-money 75 put option on Dec’18 cotton cost 2.85 cents per pound (down 43 points, week over week); a deeply out-of-the-money 65 put on Dec’18 cost 0.50 cents on Thursday.
This market is being supported by speculative buying and good demand, the latter being evidenced by the strong pace of U.S. export commitments and remaining mill fixations. But there is also a risk to see futures weaken if the remaining hedge fund longs get spooked by some risk-off event, and/or if seasonally high U.S. exports turn out to be more of a front-loaded pattern of what USDA has already been expecting. Remember, the longer term fundamental picture painted by USDA still implies price weakness by virtue of a large year-over-year increase in 2017/18 ending stocks. The same is true of the 2018/19 outlook. In the short run, the potential for a price reversal is also there because of the fickle fuel of speculative buying that underlies the market since November.
Nobody ultimately knows how high these markets could go, including new crop Dec’18. The only thing you can know for sure is whether a forward contract or a hedge on today’s futures price will be a profitable, or at least survivable, price floor.
Given all these uncertainties, growers should consider taking advantage of present (or future) rallies, and protect themselves from sudden sell-offs. Forward contracting of new crop bales, immediate post-harvest contracting of old crop bales, and/or various options strategies can be used to limit downside risk while retaining upside potential. In hindsight, contracted 2017 bales could have been combined with call options on the deferred futures contracts. New crop put spread strategies to hedge the 2018 crop are a straightforward and relevant approach. I have heard of bale and acre forward cash contracts being offered in West Texas on competitive sounding terms, e.g., 2.5 cents and 3.5 cents off Dec’18, respectively. While similarly competitive to early 2017, I understand the discounts for low micronaire are higher in these recent offerings.Source: The Cotton Marketing Planner