Cotton - Have We Priced Out Exports For The Moment?

| About: iPath Dow (BAL)

Adverse price movement can affect exports levels in commodities. In other words, if prices are low enough, it may entice higher exports, while prices appreciating too high have the ability to discourage exports. Cotton futures are flat today as of this post, unable to make it to the previous session's highs. Net export sales for the week ending August 8th were 38,502 bales -- less than half the net sales for the prior year for the same time period. One trader was quoted today as saying "that cotton is up in a price range where it's too high to make export sales."

In the last eight sessions, December cotton futures have rallied just over 8% to lift prices above 92 cents and their highest levels in 13'. It had been 16 months since December futures had traded at these elevated prices. They say a rising tide lifts all boats, as Ag has rallied in recent sessions -- granted, corn, soybeans and wheat from extremely oversold levels. Cotton had a head start as futures had not gotten hit like the aforementioned Ag commodities, trading mostly sideways for the prior 6 months. As one can see on the chart below, the trend line (blue line) was challenged on several occasions in recent months and held on all attempts. My take is once we trade south and close below the "breakout level" (red horizontal line), we trade back towards the trend line.

Click to enlarge

Two trade ideas:

Ø For aggressive traders, one could get short futures and sell (1) put option as a hedge. Current futures price is 91.50 so if you sold a just out of the money put, say 91/90 strike, you would have a 3.50-4 cent cushion, which gives you $1,750-$2,000 of protection. The deltas come in at approximately 45%, so you would realize roughly half the underlying move. The time window is just shy of 3 months, but I think you could see a trade back to the trend line near 85/86 cents in the coming weeks.

Ø My favored play is back ratio spreads in December. Today for clients I sold (1) 91 put and bought (3) 86 December puts and paid 2 cents or $1000 per strategy. You have a positive delta of 44% as of this post. An ideal scenario because you are long multiple legs is a volatile trade lower. If futures move higher as opposed to lower, you have the option of buying back the 91 leg… which in theory means you are increasing your exposure to a losing trade. A trade back to the 50 day MA puts futures back near 86 cents and should put this strategy in the green as long as it plays out in the coming weeks.

Risk Disclaimer: This information is not to be construed as an offer to sell or a solicitation or an offer to buy the financial products herein named. Trading futures, options, and Forex involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. This report contains research as defined in applicable CFTC regulations. Both RCM Asset Management and the research analyst may have positions in the financial products discussed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.