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Corn+Soybean Digest

Early Marketing Props Up Cotton Prices

Marketing one-third of his 1999 cotton crop six months before it was planted made Marvin Mode a little nervous. Now, as he and others approach the end of the growing season, he'll gladly take that 63 cents-plus/lb cash price generated by early forward contracting.

Barring any unforeseen rise in prices, most farmers will have the government loan rate of about 52 cents as their floor price. And they'll have their fingers crossed for the highest loan deficiency payment (LDP) possible.

LDP, the difference between the loan price and the adjusted world price (AWP), has been around 45 cents much of the year. Harvest prices in the 40s and even the high 30s are possible as production outlooks remain high at 18-million-plus bales.

But, as Mode demonstrates and others like cotton guru Billy Dunavant dictate, there are ways to at least protect against total price disaster.

Dunavant, the nation's most influential cotton marketer, stresses that if forecasts for the large crop are correct, growers should take steps to protect against price declines.

"Farmers should buy at-the-money puts and sell high-strike-price calls to help pay for the cost of price protection," says Dunavant, of Memphis, TN. "If (December futures) prices get to the 62-63 cents range, farmers ought to be hedging as much of their crop as possible, using put options or straight futures contracts."

Mode, who farms near Hereford, TX, had a good crop started under pivot irrigation in June. Production from his 600 acres is all covered by a current or tentative marketing strategy.

In June, about 200 acres were sitting pretty, contracted at 63.15 cents.

"The old saying is that you won't go broke by taking a profit," says Mode. "So we contracted that cotton way back in November."

In early summer, he had a standing order in place with his broker to hedge cotton from the remaining 400 acres at 59 cents or higher using December futures.

"If the 59 cents hedges are made, I'll use a scale-up program in the event the price goes up even more," he says.

Mode will also receive his LDP for every bale, as well as any benefits from taking part in his regional cotton marketing co-op's pool.

A marketing program that covers growers through options, and lets them market directly to textile mills, is available from a Savannah, GA, company called SavCot, Inc.

In this program, growers use a combination of options to protect their prices.

"With markets currently low relative to the loan price, there is little incentive for buying outright put options," says Thomas Mueller, SavCot owner-operator. "For example, (in early summer) a 58 cents December '99 put option would cost about 3.5 cents. It's very expensive. We prefer three-way strategies, in which a grower buys at-the-money puts, sells out-of-the money puts and sells out-of-the-money calls."

The cost of the at-the-money puts in the 58 cents range is mostly offset by the other transactions. "With these transactions, the cost is lowered to 100-150 points (1-1 1/2 cents)," says Mueller. "And if the market rallies, growers can take advantage and still have protection on their LDPs."

Carl Anderson, Texas A&M University extension cotton marketing specialist, says that, since the market "has a lot more downside pressure than upside potential," producers should look at buying puts and selling calls if any rally occurs.

"A floor price at around 58 cents may be difficult to reach," says Anderson.

"Buying put options at the money and selling calls some 4-6 cents above the market is one pricing alternative," he adds. "Forward contracts are another. If you contract, be sure to keep the right to collect the LDP."

Growers might consider a strategy that can provide bonuses if the market takes dramatic moves up or down, says economist Dale Stemple, a cotton marketing specialist with Amarillo (TX) Brokerage Co.

In his sample strategy, growers buy 56 cents December puts at about 2.4 cents and sell December 65 cents calls for about 0.8 cents. The put cost is lowered to 1.6 cents. If December futures drop from 56 cents to 46 cents - which is highly possible - the 10 cent swing would generate 8.4 cents in profit (10 cents less the 1.6 cents cost). If the market rallies to 66 cents, the buyer of the calls will exercise the options and will be hedged at 65 cents, less the 1.6 cent cost of the put.

"In this strategy, you don't care if the market goes up or down," Stemple says. "Money can be made in either scenario. If there is no dramatic move in the market, growers are only out the 1.6 cents/lb cost of the puts."

The USDA Step 2 program, which has provided an incentive for foreign buyers of U.S. cotton, remained defunct in early summer. It still lacked congressional funding. But even if it is enacted, don't expect major price increases.

"Step 2 would help a tremendous amount with December cotton at about 54 cents, but I don't think we'll see any rallies that go above 62 cents," says Dunavant. "Remember, each grower's situation is different. But if we have a good crop coming on, and the potential is there, they need to protect prices in any potential rally."

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