Cotton Market Update for the Week Ending Friday November 2, 2018

The week ending Friday November 2  saw ICE cotton futures trend lower, bottom out, then sharply rally over two cents on Thursday before stabilizing roughly where they started the week.

Thursday’s turnaround came despite major cancellations of export sales to China, reported on Thursday morning.  The latter more than negated an otherwise low low export sales report and further softening of the longstanding bullish picture of export commitments. The bullish trigger on Thursday was apparently a tweet by President Trump announcing a phone conversation with Chinese President Xi aimed at resolving the ongoing trade dispute.   Thursday’s rally may have been facilitated technically as prices cut both the 9 and 40 day moving averages from below.  Ongoing bullish supply fundamentals included an ongoing rainy harvest scenario in the U.S. plus continued expectations of large hurricane losses in the Southeast.

The Dec’18 contract settled on Friday at 78.79 cents per pound, about 26 points higher than the previous Friday.  The Mar’19, Jul’19, and Dec’19 contracts settled the week at 80.31, 82.51, and 78.31 cents per pound, respectively.  Chinese and world cotton priceswere mixed this week.

A sample of option premiums on ICE cotton futures saw changes from the week-over-week change in the the underlying futures.  On Thursday, November 1,  an in-the-money 85 cent put option on Mar’19 cotton was worth 6.17 cents per pound, while an out-of-the-money 75 put cost 1.07 cents. These values and their increase since August show how put options increase in value with falling futures prices, thus providing a mechanism for down-side price insurance.  An out-of-the-money 85 call on Jul’19 cotton was worth 3.58 cents per pound on Thursday, rising with the higher futures settlement that day.  Looking way out there, a near-the-money 75 put on Dec’19 cotton settled Thursday at 3.23 cents per pound.

This week provides another example of the ever present risk of unexpected market volatility.  It can happen in both directions.  For example, a surprise resolution to U.S.-China trade relations, confirmation of extensive hurricane damage, or something else totally unexpected could trigger speculative buying.  As always, the most relevant question is whether a cash 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 always be poised and ready to take advantage of 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.   Hedges with puts or put spreads on Mar’19 futures can be used to provide near term protection of old crop bales through the harvest season. Contracted 2018 bales could be combined with call options on the deferred futures contracts.  Call option strategies have become increasingly affordable with the recent decline in the futures market. New crop put strategies to hedge the 2019 crop are a straightforward and relevant approach.