The week ending September 1 saw Dec’17 ICE cotton futures take moderate stair-steps higher from around 69 cents on Monday to the weekly high settlement of 71.88 cents per pound on Friday. This level maintains an inversion over DecΆ18 cotton at 1.58 cents per pound as of Friday. Near-the-money 73 call options on DecΆ17 ICE futures cost 2.17 cents per pound on Friday, while an out-of-the-money 79 call cost 0.65 cents per pound. Near-the-money 73 put options on DecΆ17 cost 3.29 cents per pound, while a higher 75 put was 4.58 cents per pound. Out-of-the-money 66 and 67 strike Dec. puts cost 0.65 and 0.86 cents per pound, respectively.
Presumably ICE cottonΆs measured increase was in response to both the uncertainty and the potential loss of something under a half million bales from Hurricane Harvey. Other fundamental news this week included decent export sales. The pattern of normal volume and gradually increasing open interest through Thursday August 31 suggests a moderate level of new buying. Some of this was reflected by a decent increase (through Tuesday) in the net long index fund position. Further technical buying may have been spurred on late in the week by signals such as breaching the 200-day moving average.
To individual growers in HarveyΆs wake, the storm effects are a major disaster. But I do not find it unusual that there was not a stronger rally in the futures market. First of all, knocking a hypothetical half-million bales off the bottom line of the U.S. balance sheet would not translate to a nickel rise in the futures price. Second, after the uncertainty dies down, markets typically calm down too. I am expecting more a cash market response from Harvey in the form of basis volatility as premium quality cotton becomes more scarce for a while. Hurricane Harvey and its aftermath represent a more concentrated version of the uncertain weather market that cotton has faced all summer. This uncertainty will continue now around the question of whether the 2017 crop can get enough heat units and clear weather to mature. All of this uncertainty will potentially create price volatility.
Growers should be poised and ready to take advantage of any rallies, and protect themselves from sudden sell-offs. Forward contracting and/or various options strategies can be used to limit downside risk while retaining upside potential. Physical bales that have been forward contracted could also be combined with call options on DecΆ17 ICE cotton. For example, while an out-of-the-money 73 cent DecΆ17 call costs 2.17 cents per pound (circa September 1), a 73:79 Dec call spread would cost a little cheaper at 1.52 cents. A possibly still relevant strategy (for only the next month) for unsold/uncommitted 2017 bales is buying put spreads on DecΆ17 futures. But this is probably more a hindsight example now; buying puts was much more relevant back when there was more time value and when DecΆ17 futures were trading in the lower to mid 70s.
