The week ending September 15 saw a succession of sharp drops in the ICE Dec’17 cotton futures contract, before prices assumed a narrow sideways pattern almost five cents lower than where they started the week. Hurricane Irma damage, while still being assessed, appeared to have little influence at the beginning of the week. Monday saw futures trade down the three cent limit in intra-day trading, for no apparent reason other than possible WASDE pre-positioning. Then Tuesday saw a surprisingly bearish WASDE report that resulted in a limit down settlement in the front month contracts. Technical sell signals probably acted as a catalyst. Other fundamental news this week included very mediocre export sales and export shipments that continued sub-par. Dec’17 ICE cotton futures settled the week at 60.07 cents per pound on Friday. This level represents a continued inversion over Dec’18 cotton which narrowed 3.59 to 1.06 cents per pound, week-over-week. Out-of-the-money 73 call options on Dec’17 ICE futures cost 0.87 cents per pound on Thursday (down from 3.96 cents per pound the previous Friday); a further out-of-the-money 79 call on Dec’17 cost 0.18 cents per pound on Thursday. In-the-money 73 put options on Dec’17 cost 4.75 cents per pound, while a higher 75 put was 6.40 cents per pound on Thursday. Near-the-money 66 and 67 strike Dec. puts cost 0.94 and 1.27 cents per pound, respectively, on Thursday.
With the post-Hurricane Harvey rally, we may have seen the last opportunity for futures over 70 cents. There may, however, be a greater risk within six months to see futures under 60 cents. But since that is all uncertain, growers should remain poised and ready to take advantage of unexpected 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 Dec’17 ICE cotton. For example, while an in-of-the-money 73 cent Dec’17 call costs 3.96 cents per pound (circa September 8), a 73:79 Dec call spread was cheaper at 2.34 cents. However, with the decline in underlying Dec’17 futures, those calls are worth a lot less. The reason the insurance is so cheap is that the market is discounting the possibility of Dec’17 futures rising back above 73 cents.