Marketing Strategies

A marketing plan for cotton is a price contingency plan of actions that a grower/hedger will take in various possible, but ultimately uncertain, future market situations. A marketing plan can include many strategies, probably in combination with each other. These could include basic tactics like forward contracting, selling at harvest, marketing pools, and the USDA loan program. Hedging with futures and options can complement or substitute for these basic tactics. A marketing plan should include targeted price levels and calendar dates when you will take a given action. Lastly, a marketing plan should be a written document to help you remember and to take action, i.e., just like your To-Do-List.

Two goals of any hedging or cash contracting strategy should be 1) to protect from downward price moves, and 2) allow for upward pricing opportunities.  There are a number of ways to achieve both of these goals using cotton futures and options contracts.  The chart below outlines different ways of doing the same thing:

A first example in the chart involves implementing a price floor using a cash forward contract to set the price floor and eliminate basis risk.  If such contracts are combined with near-the-money call options,  then the call option (or a cheaper call spread) allows for upside price potential.  It should be noted that forward cash contracts may impose production risk, quality risk, counter-party risk, and/or legal risk on growers, as discussed here.  So always read the fine print, and perhaps spend a few hundred dollars to let a lawyer read the fine print.

Strategies using put options or put spreads generally have the advantage of providing a flexible floor against falling cash prices while allowing for upside potential while the crop remains unsold until after harvest (reflected in the second example in the chart above). 

A similar strategy to the put option strategy is to sell a futures contract and buy an near-the-money call option (the third example in the chart above).   Both of this and the put option strategy assume that growers would have cotton bales to sell in the harvest-time cash market (that is what gives you the upside potential).   Many growers (especially dryland growers) face too much production risk to assume a crop at harvest time.   In that case, the two hedging strategies described above could be applied covering a level of production at or just below the grower’s APH yield*Revenue Policy coverage level.  (Click here for more crop/revenue insurance considerations.) Both of these strategies still face basis risk.

Historical Cotton Hedging Examples. The last several decades provides examples of how different futures price patterns can be approached with the flexibility offered by options strategies. Click here to see these examples.

Hedging Whole Cottonseed.  Cottonseed hedging (i.e., by gins) represents a special case since there is no active futures contract for whole cottonseed.  So one must cross hedge with some other related commodity.  Click here to see some preliminary analysis of cross hedging whole cottonseed cash prices using soybean and soybean meal futures.

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