Put options at a given strike price cost less (or more) in a rising (or falling) market because the the put option gives the right to have sold the underlying futures contract at a specified level. The example above looks back at the performance of a $1.20 put option on the expired Dec’22 futures contract. This option had intrinsic value when the underlying futures was below $1.20, like it was during the last half of 2022. Therefore, put option premiums move opposite of the direction of the underlying futures price. This is important because an increasing put option premium can act as an insurance payment against falling futures and (assuming a stable cash basis) falling cash prices.
Back when Dec’22 was trading at 120.10 cents per pound, the associated premium for a $1.20 put option was 10.41 cents per pound. Buying it at that level was essentially buying the right to a 109.59 cent short futures position. This implied a minimum cash price around 105 per pound with upside potential and no margin call exposure. Looking back, there were several opportunities in 2022 to buy affordable and meaningful put options. 2022 was unusual in that we saw two major declines of roughly 50 cents each in five months. This at least provides more awareness of the scope of downside price risk. (Want to see more? Click here to compare/contrast hedging opportunities with put options on ICE cotton futures over the last twenty years.)
Looking at 2023, meaningful hedges with put options on Dec’23 ICE futures has been getting more affordable lately. For example, a 90-cent level put option on Dec’23 cost 5.14 cents per pound as of September 21. Buying a 90-put on that date implied a short hedged futures position of 90.00-5.14=84.86 cents per pound, but without any margin exposure. If there is a continued rally in Dec’23 futures into the low 90s, this simple hedging strategy might become even more affordable.