Put Spreads

2017 SEASON — The market for the 2017 crop has started off a lot like 2016 and 2015.  Futures were at a sub-profitable level (see the blue line above) before the new year, so there was no good opportunity to meaningfully hedge a price that would cover all production expenses.   But the rally in Dec’17 futures that began in January raised the possibility to hedge prices that are worth protecting.  For example, during the spring and summer of 2017 there were several opportunities to buy an at-the-money 73 December put for around four cents (see the red line in the chart above).  Doing so would have implied a minimum cash price in lower/mid 60’s (depending on your basis), which may not be have been worth it.  Upside price potential would still have been open.  This strategy provided price protection that would likely cover typical operating costs (but not total costs) in Texas.  Still, it would not have been a trivial thing to pay four cents a pound for such protection.  A cheaper version of this strategy would have been to buy the 73 put and also sell a 66 put for a little over a cent.  That protected the futures downside between 73 and 66 cents, and this more target protection had a net cost of between two and three cents per pound back in the Spring.  The only relevant question for someone who had implemented this strategy is when to offset the position.  The value of that put spread is tracked by the green line above.   With the decline in Dec’17 futures since the summer, a put or put spread position would have increased in value, providing partial compensation for the declining cash value of unsold cotton.  On October 12, this spread was worth 4.72 cents per pound.  (Note, such a position would would need to be exited no probably no later than the end of October, with the ultimate end date being expiration in early November.)

2018 SEASON — It is not too early to be thinking about, if not shopping for, affordable and relevant put spread strategies for the 2018 crop.  The graph below is an example of a 67:60 put spread.  In principle, the strategy works the same way as described above, i.e., protecting the range of futures prices between 67 and 60 cents.  On October 12 this partial protection costs around 2.7 cents per pound, compared to the almost four-plus cent premium for the 67 put alone.  The spread makes sense to “sell off” the put protection below a certain point since the loan rate (and perhaps revenue insurance, too) provide downside price protection for deeper price declines.


 

 

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