Will Cotton Continuation Pattern Continue?
Fundamentals
Speculative traders have been trying to pick a bottom in the Cotton futures market lately, with renewed buying interest sending prices near two-month highs. The USDA in its March 31st Prospective Plantings report estimates U.S. producers will plant 8.81 million acres of Cotton in 2009. If true, this will be 7% lower than 2008 totals and the lowest Cotton acreage in over 25 years. The weekly crop progress report released on Monday afternoon has 4% of this year's Cotton crop in the ground vs. 7% this time last year. Even though it appears that U.S. Cotton production will decline this year, it will take a continuation of improved export business in order to support prices. Cotton stocks in China and India are ample, which may discourage additional fresh buying -- especially if the recent strength in the U.S. Dollar continues, which would make U.S. Cotton more expensive to foreign buyers. There are also reports that the Chinese government will not be issuing additional import quotas to its domestic buyers this month due to large government stockpiles. Commercial and speculative traders are on opposite sides of the market, as the recent rally has caused speculative traders to decrease their short positions, while commercials are taking advantage of the recent price rise to establish additional short positions. Next up for not only Cotton but grain traders as well is the USDA crop production/supply demand report to be released on Thursday morning. Cotton traders will focus on any revisions to U.S. export totals, with some expectations for a slight rise in exports due to solid business earlier this season.
Although Cotton prices have recovered from recent lows, they still are mired in a nearly 4-month long consolidation pattern, with the contract lows in the July contract of 41.21 acting as strong support and the January highs of 53.10 as resistance. With prices currently hovering near the middle of this range and the potential for increased volatility once the growing season begins in earnest, traders looking for a breakout from the trading range and an increase in volatility may wish to investigate a long straddle position. As you may already know, a long straddle position consists of the purchase of a call option and a put option at the same strike price in the same contract month. With the current price of July Cotton at 48.05 as of this writing, a trader may wish to consider the July 48 straddle, which would cost around 635 points or $3175 per contract, exclusive of commissions and fees. Given this scenario, the maximum loss would be the premium paid, and the position would profit if July Cotton is trading above 54.35 or below 41.65 at expiration in June. Given that time decay works against a long straddle position, many traders might look to exit the position at least a couple weeks before expiration, before time decay dramatically begins to affect the position.
Technicals
Looking at the daily chart for July Cotton, we notice prices moving above the 20-day moving average. Momentum, as measured by the 14-day RSI, is reading a relatively strong 62.14, signaling Cotton bulls currently have the upper hand. The upward price spike on March 31st occurred on sharply higher than average volume, which may signal fresh buying has entered the market. Trading volume since then has subsided somewhat, as traders square their positions ahead of the USDA report on Thursday.
Mike Zarembski, Senior Commodity Analyst
