Cotton Market Update for the Week Ending Friday October 5, 2018

The week ending October 5 saw ICE cotton futures gyrate in a sideways pattern that began Monday with a two cent trading range around a slightly changed settlement.  Tuesday through early Thursday showed a very slight uptrend to the gyrations until a very weak export sales report triggered a down-shift in price level. Other fundamental cotton market influences this week included reportedly light demand in major U.S. markets (also reported to me from Texas buyers), some export cancellations to whittle down the seasonally high level of export commitments,  and unhelpful rainfall along the Gulf Coast and Atlantic Seaboard. Northwestern Texas has caught up with the eastern Cotton Belt in that recent rains are increasingly a negative influence on grades if not yields.  The latest Commitment of Traders snapshot shows continued erosion of the hedge fund net long position, now the lowest in fourteen months.

The Dec’18 contract settled on Friday at 76.10 cents per pound.  The Jul’19 contract settled the week at 78.71, while the distant Dec’19 settled Friday at 75.75 cents per pound.  These levels were within 30 points of last week’s settlement.  Chinese and world cotton prices both trended lower this week.

A sample of option premiums on ICE cotton futures saw changes from prior weeks due to declines in the the underlying futures.  On Thursday, October 4, a deep in-the-money 90 cent put option on Dec’18 cotton was worth 14.06 cents per pound (up from 9.05 cents three weeks prior). Similarly, an 85 put settled Thursday at 9.16 cents per pound while an 80 put settled at 4.58 cents per pound, both increasing in value over the past couple of weeks. These values and their weekly change show how put options increase in value with falling futures prices, thus acting as down-side price insurance.  An out-of-the-money 85 call on Jul’19 cotton was worth 2.23 cents per pound, down 2.14 cents from three weeks prior.  Looking way out there, a near-the-money 75 put on Dec’19 cotton settled Thursday at 4.53 cents per pound.

This week provides another example of the ever present risk of unexpected market volatility.  It can happen in both directions, as it did in Monday’s session.  For example, a surprise resolution to U.S.-China trade relations, extensive damage from another hurricane, revising Indian stocks downward by USDA, 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.   Earlier hedges with puts or put spreads on Dec’18 futures should be evaluated with an eye towards exiting those positions this month.  With the recent decline in the futures market, put strategies have been accruing value.  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.