Sterling Terrell

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What is the Best Season for Selling Cotton?

What is the Best Season for Selling Cotton?

I love this time of year. Less heat. More cool air. Clouds roll in. School is back in session. Harvest time is here. We start thinking about the upcoming holiday season. We worry about what relative’s house we will be spending Thanksgiving and Christmas at – and more importantly what the sleeping arrangements will be.

In The Seasons, Oliver Wendell Holmes wrote

“The foliage has been losing its freshness through the month of August, and here and there a yellow leaf shows itself like the first gray hair amidst the locks of a beauty who has seen one season too many….”

On that note, football is hard to not enjoy.

What is better than a game of touch football in the backyard with your friends as a child? A Friday night game in high school, whether you are cheering from the stands or playing on the field?

Tailgating before the big rivalry game while in college, and cheering your team to victory? Or, firing up the grill with friends on an NFL-filled Sunday afternoon while your children run and play in the yard?

I submit that there is a specific season that goes best with football. Football is certainly no summer sport.

In that same way, is there a season that goes best with selling your cotton?

Or maybe, said better: Is there a time of year that cotton prices are on average higher or lower?

On the optimal time to sell cotton, I have heard it all from growers before:

“You should never sell your cotton on a Friday.”
“You should never sell your cotton before the first of January.”
“Cotton’s price is always lowest in December – and highest in April.”All of these statements allude to the same thing. But I ask again, what does the data tell us?

As luck would have it, the work has thankfully been done for us. Economist Gary Raines of INTL FCStone has written a beautifully concise paper entitled Another Look at Seasonality in ICE Cotton Futures that answers this question superbly.

Raines looked at monthly data from October 1972 – October 2012. To fish out the answer of seasonality, each monthly price was converted into a ratio of monthly price and average annual price.

The research found:

“…ICE cotton futures show a pronounced pattern of seasonality, with prices typically above average in the first half of the year and below average from July through December. These periods follow conventional wisdom given the bulk of the global cotton crop is grown in the northern hemisphere, where harvest typically happens from August through December. These two distinct periods of seasonality show cotton futures are typically one to 3.5% more expensive during the first few months of the year and are one to 3.5% less expensive during several of the latter half of the calendar year.”

This means that if cotton prices averaged 85 cents per pound during a year we would, on average, expect that during March through May prices would be around 88 cents per pound. At the same time, we would, again – on average – expect that during August through November prices would be around 82 cents per pound.

For a producer averaging 1,00 bales a year, capitalizing on this seasonality amounts to capturing an additional 15,000 Dollars in revenue in our example year. If continued, that would amount to 450,000 Dollars over a 30-year career.

Yes, seasonal prices are lower and higher in some years than in others. Yes, we are dealing in averages. Yes, these findings are not an end-all-be-all solution. But is it not better to have, and to know that there is a seasonal effect to cotton prices than for one to not exist at all?

That said, if it is November and cotton prices are approaching two dollars per pound, you might be wise to go ahead and sell your current crop, and hedge next years crop – instead of waiting for the average seasonal shift in March – May.

In that case, forget seasonality. Enjoy whatever season it is!

And take the money.

First published by Cotton Grower.

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Filed Under: PotpourriTagged With: #Cotton, #CottonMarketing

Option Hedging: The Virtue of Second Best

Option Hedging: The Virtue of Second Best

Second best is not all that bad, is it?

Phil Mickelson has come in second place in the U.S. Open six times, and he has an estimated net worth of nearly $200 million. This is because coming in second place (or close to it) time after time, while everyone else is inconsistent, can make you one of the best golfers in the world.

In the world of cotton marketing, can second best work?

I have talked about selling before. I believe I actually said, “If the price works for you, sell!” And Dr. O.A. Cleveland once said, “If you like the price enough to plant it, then like the price enough to sell it.”

I wish I had said that first. But I digress.

This simply means that when prices are attractive, producers should consider locking in prices or “selling forward” the to-be-harvested crop. In this pursuit, options are a great tool – specifically, hedging cotton prices through buying put options. This means the buyer of a put option has the right, but not the obligation, to sell at an agreed-upon price at some point in the future. This right comes with a cost (premium).

The reason I like option hedging is simple – in most cases, buying put options as a hedge against your cash crop will be the second best choice you could have made. It also allows us to stay away from the frequently seen “Texas-Hedge, all-or-nothing, paralyzed-with-indecision marketing plan.”

Let’s look at three examples, using persons X, Y and Z.

15 Cent Cotton Price Decrease
In July, Dec. Cotton Price = $.85/lb
X hedges with Forward Contract @ $.85/lb
Y hedges with Put @ $.85/lb (Premium Cost = $.05/lb)
Z does not hedge

November, Dec. Cotton Price = $.70/lb
X sell price = $.85/lb
Y sell price = $.80/lb
Z sell price = $.70/lb

In the first example, X forward contracted his cotton and received the best price. Y, the put option buyer, did second best by locking in his cotton at $.85/lb, but receives a net of $.80/lb after subtracting the cost of purchasing the put contract. Z simply looks foolish for doing nothing when he had the opportunity to lock in higher prices.

15 Cent Cotton Price Increase
In July, Dec. Cotton Price = $.85/lb
X hedges with Forward Contract @ $.85/lb
Y hedges with Put @ $.85/lb (Premium Cost = $.05/lb)
Z does not hedge

November, Dec. Cotton Price = $1.00/lb
X sell price = $.85/lb
Y sell price = $.95/lb
Z sell price = $1.00/lb

In this scenario, X forward contracted his cotton exactly the same as before, but now looks foolish for locking in his prices so low. Again Y, the put option buyer, did second best by selling his cash crop for $1.00/lb, but nets $.95/lb after subtracting the cost of the put. Z gets $1.00 for his cotton and looks like a genius for doing nothing until harvest time.

Cotton Prices Are Constant
In May, Dec. Cotton Price = $.85/lb
X hedges with Forward Contract @ $.85/lb
Y hedges with Put @ $.85/lb (Premium Cost = $.05/lb)
Z does not hedge

November, Dec. Cotton Price = $.85/lb
X sell price = $.85/lb
Y sell price = $.80/lb
Z sell price = $.85/lb

With prices constant, it doesn’t matter if the cotton was forward contracted or sold for cash. Both X and Z received $.85/lb, and Y – yet again – is second best after the cost of a put option is factored in.

However, in the final example, is our put option buyer really worse off than the other two growers?

Arithmetically, yes, because he received five cents per pound less for his cotton lint. But, look at the risk profiles for all three.

In the final example, the option buyer Y actually looks quite good. He sold cotton at $.80/lb, but only risked $.05/lb in the premium cost of the option to get to that price. However, X and Z sold cotton at $.85/lb cotton, but both risked potentially unlimited amounts of forgone revenue in doing so.

That’s because X, who forward contracted his cotton, ran the risk of cotton going to $1.00/lb (or higher) and having to deliver cotton at $.85/lb. That equals at least $.15/lb in forgone revenue. Z – who always sells cash cotton – also ran the risk of cotton going to $.70/lb (or lower) and also faced a potential $.15/lb (or more) in forgone revenue.

There are other examples to discuss using my numbers when prices fluctuate between $.80/lb and $.90/lb that show options hedging as the third best alternative. But to that I would ask the same question – how much potential revenue (like in scenario three) was risked for a marginally higher price?

Think about it.

Buying put options can be a powerful marketing tool for producers to minimize risk and lock in high prices. They also have the added benefit of leaving the topside – for potentially higher prices – open to increase.

So here’s to second place…and marketing cotton like Mickelson plays golf.

First published by Cotton Grower.

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Filed Under: PotpourriTagged With: #Cotton, #CottonMarketing

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