Cotton Supply Outlook Should Favor Call Selling Strategy Now
Cotton Prices Have Been Trending Higher, Driving Up Call Premiums. But the Tables Now Appear Ready to Turn.
Cotton prices have been a prime benefactor of growing world economies and overseas demand. Since a post harvest low back in October, cotton prices have rallied by nearly 12%.
This has helped inflate call option premiums in the cotton market nicely.
But with Spring approaching, a not-so-bullish supply outlook taking shape, and now at least the possibility of import tariffs on US cotton from some nations, cotton prices could soon be facing headwinds. Fundamentally, its what we would deem a solid set up for a call selling approach .
Springtime Seasonals Favor Bears
Seasonal price tendencies can play a big role in agricultural price forecasting. US Agricultural Markets have historically tended to strengthen during Springtime. This is largely due to the fact that US planting takes place in the Spring. Uncertainly over acreage and weather have historically tended to create anxiety in the markets, making bulls more eager to take positions and bears more fearful of jumping the gun on successful planting. In grains, this “planting anxiety” often happens in the late Spring – April/May time period. Once successful planting has occurred however, and crops deemed safely “in the ground,” it is not uncommon to see prices weaken as anxiety tends to fade.
…historically, it is not uncommon to see cotton prices strengthen into March, only to give way to weakness into the spring…
Cotton has tended to display this same historical price cycle . However as the majority of the US cotton crop is planted in the south, planting tends to occur earlier in the year. Thus the “planting anxiety” premium tends to build into the market earlier. But it also tends to fade earlier. Thus, historically, it is not uncommon to see cotton prices strengthen into March, only to give way to weakness into the spring and summer growing season.
This tendency is illustrated in the seasonal chart below:
Cotton prices have tended to strengthen through planting season, then give way once the new crop planting is complete(past performance is not indicative of future results.)
As we will see, cotton prices appear to be tracking this seasonal tendency almost perfectly in 2018.
2018 Cotton Supplies Burdensome
The latest USDA supply numbers show US cotton supplies at burdensome levels. 2017/18 US ending stocks are pegged at 6 million bales – the highest in a decade and nearly double 2016/17 levels. US Stocks to usage at 33.6% is also a sharp increase from last year and the highest since 08/09. This sets a bearish backdrop for US cotton prices in 2018.
Global Stocks to Usage at 73.5% is also near multi year highs. While the USDA is expected to lower global stocks slightly in its next (March 8) report, US planted acreage in 2018 is expected to see a sizable increase over last year. This does not bode well for a longer term continuation of the recent uptrend.
2017/18 US Cotton Ending Stocks will be the highest in 10 years.
Conclusion and Strategy
With both seasonal and big picture supply fundamentals appearing bearish, cotton prices should soon begin seeing some resistance to higher prices. Planting is well underway in the US Delta regions. And while a spate of dry weather has brought some buying into the market, it remains very early in the season. In addition, US cotton planted acreage is expected to see an increase over last year.
Any blow-backs from the US’s plans for tariffs on foreign steel and aluminum remain to be seen. However, agriculture is a big sector of US exports and could potentially become a target should other nations elect to retaliate. Should such tariffs occur in cotton, effects would likely create a further bearish force for cotton.
Further US weather issues, continued strong global demand and a slight lowering of global stocks could all be potentially bullish for prices. However, we feel seasonal pressures and overbearing US supply will be too big of a burden to overcome. The path of GREATER resistance is higher.
Thus, the right strategy for such a fundamental set up is a call selling approach.
Fortunately, weather related volatility has now inflated distant call premium to attractive levels.
We will be targeting a variety of strategies for current managed client portfolios .
December 2018 Cotton
December Cotton Showing 90.00 Call Strike Price. If December cotton is ANYWHERE below the 90.00 at option expiration, the seller keeps all premium collected as profit.
Self directed traders can consider selling theDecember 90.00 cotton calls. Current premiums are in the$500 range. Margin requirement is approximately $1,130. Thus, should the options expire worthless (in November,) the sale would produce a roughly 44% return on equity. (risk of loss, of course, is present in all futures and options trading.)
Whether the market treks higher in the short term remains to be seen. S ellers of options don’t have to pick highs and lows in the market. They only have to pick price points of where the market shouldn’t go. Considering current fundamentals, the strategy above would seem to fit that criteria nicely.
OptionSellers.com is a wealth management firm located in Tampa, FL offering option selling portfolios as an uncorrelated, potentially high yielding alternative to the stock market . For more information on managed portfolios with James Cordier and OptionSellers.com, visit www.OptionSellers.com/Discovery to request a Free Investor Information Pack. (Recommended Investment US $1 MM+)