History provides examples of hedging opportunities with ICE cotton futures and basic options strategies. Moving chronologically, the first example is December 2003 whose unexpected late-season rally in ICE cotton futures highlights the need for upside price flexibility in your marketing strategy. The second example highlights the need for a price floor when you have a reasonable expectation (but still ultimately uncertain) of a major price decline, as in early December 2004. The third and fourth examples are from December 2005 and December 2006 when ICE cotton futures traded in a narrow band below most growers’ costs of production. In this situation, insuring a meaningful price floor using put options would have been more expensive, so various spread strategies could have been employed to finance the core put option strategy.
The December 2007 contract shows how more volatile and higher prices provided more opportunities to set a flexible floor using options. December 2008 shows a picture of volatility and relevant option hedging (with some caveats about accessing and/or affording the options). December 2009 also saw large price swings, with opportunities for options to provide insurance coverage (but not much insurance payout, as it turned out).
The historical rally in December 2010 ICE cotton futures is an extreme case of volatility and potential option hedging. Probably the most notable opportunity in the 2010 case was for those who purchased $1.00 call options on Dec’10 in about August, not because they could see the future but because it was a relevant and very cheap insurance buy. The pattern of December 2011 and December 2012 both involved declining prices from a very high level, following a statistical phenomenon known as “mean reversion”. Because of the expense of put options, 2011 was a situation where put spreads would have been relevant for making downside price protection more affordable. The 2012 case is one where purchasing downside price protection from put options was relatively affordable. December 2013 ICE cotton futures did not provide much opportunity for affordable price insurance, unless you waited until about July to purchase it.
December 2014 ICE cotton futures, similarly to the December 2004 contract, illustrates meaningful and affordable opportunities to hedge higher prices earlier in the season, as insurance against declining prices. In contrast, December 2015, like December 2005 and December 2006, gyrated in a sideways pattern at a relatively unprofitable level. These latter kinds of patterns to not lend themselves to simple option strategies.
December 2016 ICE cotton futures prices were in an uptrending pattern across that growing season. A put option strategy would have been rational, even though it would have represented un-needed price insurance (after the fact). The December 2017 case presented a sideways-then-lower pattern that might have benefited from put option hedging, depending on the timing. The December 2018 example also illustrates the complications of timing and lack of affordability of simple option strategies.
December 2019 ICE cotton futures peaked during the first half of the season and downshifted into the harvest period. Simple, season-long put option strategies were applicable to this situation. The December 2020 ICE cotton contract gyrated in four big opposing trends across the year, ending with high harvest-time prices and seasonal lows for the expiring put option premium. The December 2021 contract, similarly to December 2016, trended higher across the season, negating any potential payout from put option price insurance. December 2022 ICE cotton futures peaked mid-year, fell fifty cents, recovered to back over $1.10, then declined 45 cents. Put options purchased earlier in the year would have been effective downside price insurance.