Bullish USDA Report Sparks Cotton Rally
Fundamentals
Cotton bears have been running to the exits the past couple of days, as short-covering buying ahead of Tuesday's USDA report and estimates for increased U.S. Cotton exports have put a halt in the recent sell-off. The Department of Agriculture raised its estimates for 2009-10 U.S. Cotton exports to 12 million bales, which is up 1 million bales from January's estimate. U.S. January Cotton exports totaled 1.8 million bales according to the USDA. The size of the increase caught traders off guard and was viewed as extremely bullish by analysts just after the report was released. Increased Cotton usage out of China and India, the world's largest and second largest consumers of Cotton respectively, was responsible for the increased estimate, with the USDA raising China's Cotton consumption to 47.5 million bales, vs. 46.75 million bales in January's estimate. India's Cotton consumption was raised to 19.2 million bales, up 0.45 million bales from January's estimate. The government also lowered U.S. Cotton ending stocks to 3.30 million bales due to the increased exports estimate. Despite the fact that the government data was viewed as friendly to Cotton prices, some traders fear that the recent strengthening of the U.S. Dollar coupled with the Chinese government's attempts to slow down its economy may diminish U.S. exports in the coming months. If true, Cotton prices may fall into a consolidation phase as traders await the first USDA planting intention estimates due out on March 31st.
Trading Ideas
The USDA report seems to have brought an abrupt halt to the recent downtrend in Cotton prices, however there are still concerns that Chinese Cotton demand may slow -- especially if the Chinese government's efforts to slow its rapid growth rate increases. These fundamentals may signal a movement towards a consolidation in Cotton prices in the near-term. One trading strategy that can take advantage of a sidewise market is to sell strangles in Cotton options. An example of such a trade would be to sell the May Cotton 80 calls and sell the May Cotton 66 puts. With May Cotton trading at 73.01 as of this writing, this strangle could be sold for about 220 points, or $1,100 per spread, not including commissions. The premium received would be the maximum potential gain on the trade, which would be realized if May Cotton is trading below 80.00 or above 66.00 at the options expiration in April. Given the potential unlimited risk in selling strangles, a strong focus on risk management is essential. With both strikes residing out of major support or resistance areas, some traders may possibly wish to exit the trade early if May Cotton trades above 80.00 or below 66.00 before the options expire.
Technicals
Looking at the daily chart for May Cotton, we notice the abrupt turnaround in prices after last week's capitulation selling did not find any follow-through to start the week. Tuesday's steep up-move took prices above both the 20 and 100-day moving averages, which helped to trigger buy-stops from weak speculative holders of short Cotton positions. The 14-day RSI has moved sharply higher, currently at 52.93, after falling as low as 31.18 last Friday. Friday's lows of 67.80 now becomes support for May Cotton, and the recent high at 77.83 made on January 4th, looks to be strong near-term resistance.
Mike Zarembski, Senior Commodity Analyst
