For the week ending Friday, July 30, Dec’21 ICE cotton futures finally climbed enough to settle over 90 cents (Tuesday), touch 91 cents (early Wednesday), hang in with Wednesday and Thursday settlements above 90 cents, before sliding a cent Friday on apparent end-of-the-month profit taking (see chart above courtesy of Barchart.com). Friday’s settlement was 89.39 cents per pound, down 92 points on the day.
Continuing influences include reportedly inactive physical trading with variable demand, rising Chinese and world cotton prices, a down-trending U.S. dollar, and stock markets topping out at new record highs. Currency and equity markets both appeared influenced by pandemic uncertainty, disappointing economic indicators, and thus greater expectations of dovish Federal Reserve policy (i.e., bad news is good news). U.S. cotton certified stock levels continued to erode after peaking in late June. Cotton-specific fundamental factors this week included continued good demand for the Chinese Reserve sales, seasonally normal U.S. export sales, and normally/beneficially hot summer weather. The southwestern region needs these heat units to make up for delayed fruiting in the Plains and delayed maturity along the Gulf Coast.
Open interest in ICE cotton futures rose this week, while ICE cotton futures price settlements were climbing. This suggests some new spec buying, at least through Wednesday. Indeed, the Tuesday snapshot (through July 27) showed more long positioning in ICE cotton futures with 8,292 more hedge fund longs, week over week, in addition to 64 covered hedge fund shorts. In addition, the same CFTC report also showed 709 more index fund longs, week over week.
The movement of ICE cotton futures has implications for potential hedging strategies. The price volatility in Q1 and Q2 is a reminder why it is risky to hedge by selling futures — but it’s also made some option premiums more expensive. As new crop Jul’22 cotton futures rose and fell in the last few months, a near-the-money 85 call option has increased and decreased, respectively, in value. On July 29, a near-the-money 85 call option on July’22 settled at 9.37 cents per pound. This is pretty expensive, reflecting a whole lot of time value between now and June, 2022. Had it been purchased in the previous months, the current uptrend represents the insurance aspect of call options. In general, a call option represents upside price risk protection, in combination with cash contracting or selling futures.
The rising Dec’21 contract has resulted in an out-of-the-money 75 cent put option premium declining from 4.45 cents (January 28) to 3.68 cents (February 4) to 2.79 (February 11) to 2.36 cents per pound on February 25. This option traded for 2.38 cents per pound on March 11, and then 5.29 cents per pound on March 25, with the underlying futures slipping below 80 cents. However, Dec’21 futures now over fifteen cents out-of-the-money, the 75 cent put was worth only 0.44 cents per pound on July 29.