Cotton Market Update for the Week Ending Friday July 20, 2018

The week ending July 20 saw Dec’18 ICE cotton futures gyrate mostly within an 86.50 to 88.50 cent range.    The pattern of rising open interest was relatively static, as were the actual daily settlements.  Other fundamental influences this week included decent new crop export sales, sub-par export shipments, and scattered rainfall which again mostly missed Texas.  Higher temperatures statewide and increasing water demand by blooming cotton fields will make the next several weeks very influential.  The strengthening U.S. dollar may be acting as a headwind to cotton and other traded commodities. Continuing uncertainties about trade disruptions may have also weighed on markets late this week.

Dec’18 futures settled 47 points lower on Friday at 87.08 cents per pound, which is 76 points lower than the previous Friday.  Jul’19 settled near there at 87.11 cents per pound.  A sample of option premiums on ICE cotton futures saw changes from the previous week because of the modest decline in the underlying futures prices.  On Thursday, July 19, a near-the-money 90 cent put option on Dec’18 cotton cost 5.91 cents per pound, which was a bit more expensive than the week before.  Similarly, 85, 83, and 80 puts on Dec’18 settled Thursday at 3.13, 2.29, and 1.35 cents per pound, respectively.  These values highlight the continuing opportunity to hedge minimum cash prices above projected costs of production.  An in-the-money 85 call on Jul’19 cotton was worth 7.97 cents, while a near-the-money 90 call cost 5.96 cents per pound.

This market remains supported by long speculative positioning, and emerging fundamental factors.  The speculative support under prices always comes with a risk that hedge fund longs might get further spooked by some unforeseen risk-off event, be it trade or weather related (e.g., a good rain in Texas).  On the other hand, a surprise resolution to U.S.-China trade relations or damaging weather could increase speculative buying again.  I would not at all be surprised by one more good weather rally in the next six weeks.  Nobody ultimately knows how high or low these markets could go.  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.  Contracted 2018 bales could be 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.  Competitive bale and acre forward cash contract opportunities in West Texas were available earlier in the Spring, but the ongoing drought conditions and price volatility have put a damper on that.   So grower hedging may be the main tactic to take advantage of the present opportunity.