No Soft Landing for Cotton!
Wednesday, July 27, 2011
Some traders who are looking to try to pick the low in December Cotton may wish to explore the purchase of a bull call spread in Cotton futures options. For example, with December Cotton trading at 100.25 as of this writing, the December 105 calls could be bought and the December 110 calls sold for about 1.80, or $900 per spread, not including commissions. The premium paid would be the maximum potential risk on the trade and has a potential profit of $2,500 minus the premium paid which would be realized at option expiration in November should December Cotton be trading above 110.00. Some more aggressive traders may wish to explore selling an out-of-the-money put as well, to help offset the premium paid on the bull call spread.
Fundamentals
"What a difference a year makes!" That has to be the refrain of Cotton traders who are witnessing the historic fall from all-time highs at well over $2 per pound to a new crop December contract now trading below $1 per pound. Record high prices have certainly curtailed demand for Cotton, with buyers holding off on purchases awaiting new-crop supplies to come to market and sharply lower prices than a year ago. India is expected to produce a large Cotton crop this year, which would add another competitor to the US for the export market. Given record high prices, many expected to see a US Cotton production increase; however, Mother Nature had other ideas, as a severe drought in Texas has the Cotton crop there in dire straits. The weekly crop progress report released on Monday afternoon had the US Cotton crop rated 29% good to excellent, which is down from 68% this time last year. The ratings in Texas were even worse, with only 13% of the crop rated good to excellent and nearly 60% rated poor to very poor. Only timely rains in the southeastern parts of the Cotton growing region are keeping the good to excellent ratings as high as they are. Long liquidation selling has kept futures prices weak, but there are now some signs that the market may be forming a base just below 100.00 in the December contract. The most recent Commitment of Traders report shows large and small speculators starting to add back to their net long positions after several weeks of liquidation selling. Many traders will also keep a close eye on the weekly export figures to see if fresh buying out of Asia, and particularly China, begins to emerge now that prices have fallen below $1.
Technical Notes
Looking at the daily chart for December Cotton, we notice that the market made a head and shoulders top, and when the "neckline" was broken to the downside, prices plummeted. The 20-day moving average crossed below the 200-day moving average, which is most commonly viewed as a negative indicator for prices. For the bulls, we do see a bullish divergence forming in the 14-day RSI, which has also moved out of oversold territory with a current reading of 32.53. Tuesday, upside reversal in prices after reaching yearly lows may find additional buying by bears covering their short positions after Tuesday's limit-up move. Support for December Cotton is seen at Tuesday's low of 93.20, with resistance found at the 20-day moving average currently near the 107.50 area.
Mike Zarembski, Senior Commodity Analyst
