The week ending Friday, May 14 saw most active Jul’21 ICE cotton futures take an early dip, trade sideways prior to Wednesday’s WASDE report, then trend lower to the weekly lows (see chart above courtesy of Barchart.com). Friday saw the beginnings of an uptick which reversed to the downside, settling at 82.43 cents per pound. Continuing influences include reportedly light demand and inactive physical market, mixed Chinese and world cotton prices, sell-offs and recovery in grain and oilseed futures, a higher U.S. dollar, volatile stock markets, and higher than expected inflation indicators. Cotton-specific fundamental factors this week included expected USDA supply/demand estimates (old crop) and projections (news crop), in addition to weak U.S. export sales. Certified stock levels remain static. New crop cotton futures showed continued signs of weather market influence with trading appearing to respond to rain forecasts.
Open interest in ICE cotton futures was mixed this week, while prices were mostly declining. The clearest appearance of long liquidation was Thursday to Friday, but that can’t be confirmed until next week’s Commitment of Traders. Meanwhile, the regular Tuesday snapshot (through May 11) of speculative positioning in ICE cotton futures showed a mere 792 liquidated hedge fund longs, week over week, as well as the addition of 1,048 hedge fund shorts. The same CFTC report also showed 3,340 additional index fund longs, week over week.
In addition to apparently recovering demand, there are potential longer term influences related to increased Chinese mill buying in response to policies such as 1) China making available 3.2 million bales worth of import quota, 2) continued Chinese restrictions on Australian cotton, and 3) potential impacts from U.S. sanctioning of cotton products from Xinjiang. But these latter influences remain to be seen.
The rise and fall of ICE cotton futures has implications for potential hedging strategies. The price volatility in Q! 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 Jul’21 cotton futures rose during February, an in-the-money 80 call option on July’21 increased in value from 3.71 cents (January 28) to 6.23 cents (February 4) to 7.34 cents (February 11) and to 11.87 cents per pound on February 25. In general, an old crop call option represents insurance protection for those who purchased such an option earlier, in combination with cash contracting or selling futures. This option premium (and insurance benefit) has fluctuated lower and higher with the pattern of the underlying futures, settling April 29 at 7.62 cents per pound. One week later on May 6 it settled at 11.07 cents per pound, and back to 5.75 cents per pound on May 13.
Similarly, 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, with the recent gain in Dec’21 futures, the 75 cent put was worth only 2.29 cents per pound on May 6. While this is less relevant as downside price insurance, it implies that higher strike prices are more affordable.