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 at-the-money call options, then the call option (or a cheaper call spread) allows for upside price potential. During the first quarter of 2018 there have been forward contract offerings in West Texas on relatively good basis terms. This include APH-based acre contracts, which are particularly useful in riskier dryland settings. These contracts would allow growers in 2018 to fix cash prices at or above 70 cents per pound. It should still 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). During the spring and summer of 2017, a strategy of buying at-the-money put options would have enabled growers to plan for a minimum cash price in the mid-60s, while preserving the potential to sell at higher cash prices if they happen. While not as good as forward contracting above 70 cents, a mid-60s minimum cash price would still cover most if not all production costs in the typical West Texas setting. And the put option strategy is always available for the grower to implement, unlike forward contracting opportunities. Note: the rise in Dec’18 futures since November of 2017 has made hedging new crop bales with put options a more meaningful and affordable strategy.
A similar strategy to the put option strategy is to sell a futures contract and buy an at-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. Recent history 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.