Cotton / Rice Risk Management & Marketing Strategies Carl Anderson Texas A&M University

Plan to Manage Price Risk Producers control when & how to price Prices are volatile – Cotton price can vary by 75 % from season to season Marketing plan is essential

Markets are not going to GIVE you anything; TAKE pricing opportunities from the market

Marketing Plan Financial condition Estimated costs (Breakeven Price) Develop market expectations Pricing alternatives Discipline Consider worst case scenario Risk bearing ability Cash flow needs Implement your plan

Understand Market Supply / Demand Basic patterns Seasonal variation – high for 13 out of last 16 years between May and September – but 7 of the 13 in year prior to harvest

Cotton Futures High & Low Prices ( )

Options Offer additional flexibility Used alone, with forward contracts & with futures – eg., hedging with put options allow upside opportunities

Pricing Alternatives (1997 Crop Example) Pre-harvest: (between January & August) 1. Buying put 2. Forward contract 3. Forward contract & Buy call 4. Synthetic put - Sell futures & buy call 5. Sell futures 6. Buy put & Sell call Harvest: 7. Sell at harvest & buy call

1. Buying Put for 1997 Crop Buy Dec ’97 put cents/ lb Strike price78.00 Premium Basis Net (excluding commissions)69.25

1. Buying Put for 1997 Crop Result: Downside price move covered Advantages: Benefit from price increase, no margin deposit, easy to use Disadvantages: Premium cost, fixed quantities, basis risk, commission fees

2. Forward Contract cents/ lb Futures price78.00 Basis Net (excluding commissions)73.00

2. Forward Contract Result: Fixed price Advantages: Easy, no margin deposit, no brokerage fees, flexible quantity, avoid storage costs Disadvantages: Limits gain, not flexible once signed, local contractor may not exist, payment hinges on solvency of contractor

3. Forward Contract & Buy Call cents/ lb Forward contract73.00 (as in #2) Premium Dec ’97, 78  call Net (excluding commissions)69.00

3. Forward Contract & Buy Call Result: Minimum price contract, floor set, potential for higher price Advantages: Minimum price helps in obtaining credit, no margin calls Disadvantages: Premium payment required, brokerage fees, may lose time value

4. Synthetic Put - Sell futures & Buy Call cents/ lb Sell Dec’97 futures78.00 Basis Premium Dec’97, 78  call Net (excluding commissions)69.00

4. Synthetic Put - Sell futures & Buy Call Result: Protection from price drop, upside protected from margin costs Advantages: Protect margin risk, may cost less than a put, flexibility Disadvantages: Margin deposit and possible margin calls, fixed price level

5. Sell Futures cents/ lb Sell Dec’97 futures78.00 Basis Net (excluding commissions)73.00

5. Sell Futures Result: Establishes price subject to basis variation Advantages: Reduces risk of price decline, many buyers, formal exchange rules Disadvantages: Limits gain, margin deposit, basis risk, brokerage fees, standardized quantity

6. Buy Put-Sell Call for 1997 Crop Window Cents / lb Premium, buy ’97, 78  put Sell ’97, 84  call Net (excluding commissions) Min selling price = ( )+1.75 = Max selling price = ( )-2.00 = 77.00

6. Buy Put-Sell Call for 1997 Crop Window Result: Both a ceiling and floor price Advantages: Best when prices are likely peaking, lowers cost of options, higher minimum price Disadvantages: Margin deposit required, basis risk, ceiling unless further action, brokerage fees

7. Sell at Harvest, Buy Call Option Marketing Alternative: Sell crop instead of storing and purchase call option ExampleCents / lb Cash price in November$0.65 July $0.70 call premium Net to farmer $0.615

7. Sell at Harvest, Buy Call Option $ (80 points) per pound per month for holding costs (estimated holding costs per bale per month, $2.25 for interest, $1.75 for storage; $4.00 per month total holding costs divided by 500 pounds per bale) $3.50 Call premium= 4.38 months for 80 points/lbs./mth./storgae storage costs to equal to premium cost of option

7. Sell at Harvest, Buy Call Option Advantages: No storage cost, benefit from price increase, no margin calls, can “roll” to distant futures, flexible Disadvantages: Premium & brokerage costs, fixed expiration, fixed contract size, quality may differ from futures