Put Spreads on New Crop

The chart above shows, in hindsight, how a put option with a mid-70s price coverage level (“strike price”) provided downside price protection if it had been purchased during the winter. It reflects the “old crop” situation, looking back, but it may also represent the opportunity that the new crop market may present during the winter or spring.

In the chart above, as Dec’20 cotton futures (the blue line, above) declined between February and April, the premium for a 75 put option bought earlier would gained roughly the same amount of intrinsic value (because the put gives the right to have sold Dec’20 futures at 75 cents).  This gain in the option premium in early 2020 shows how put option premiums move opposite of the direction of the underlying futures price, and hence act as insurance against declines in futures and cash prices (assuming a stable cash basis).

Unfortunately, this strategy is applicable only in hindsight.  The opportunity to hedge meaningfully high prices against downside price risk is not available currently.  One could be shopping for puts in the mid-60s, but that is a different proposition.  To some extent, federal program price and income support (from increasing LDP and seed cotton PLC payment rates) would do the same thing as a 65 put if ICE futures fall below 60 cents.

 

 

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