Hedging Against Falling Cotton Prices using Cotton Futures

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Cotton Futures

Cotton has been used in textile production for over 7000 years. Today, its uses have expanded to include products like fishnets and gunpowder. The early history of the cotton industry in the U.S. is marred by bloodshed and slavery. However, since the advent of mechanized harvesting, the U.S. has been able to maintain its position as the number one exporter of cotton without manual field labor. Cotton accounts for 35% of total fiber use around the globe. The U.S., along with India and China produce over 65% of cotton used by citizens of the world. Many developing countries find it hard to compete in the international market due to low product prices and a lack of fair trade, especially since their access to the same agricultural technology as affluent countries is limited.

Cotton Futures Contract Specifications
Product Symbol CT
Contract Size 50,000 pounds net weight
Price Quotation Cents and hundredths of a cent per pound
Contract Months March, May, July, October, December
Minimum Fluctuation 1/100 of a cent (one “point”) per pound equivalent to $5.00 per contract.
Settlement Procedure Physical Delivery
Daily Price Limit Futures contracts are subject to a daily price limit that can range from 3 to 7 cents per pound. Click to view Rules
Delivery Points Galveston, TX; Houston, TX; New Orleans, LA;. Memphis, TN; Greenville/Spartanburg, S.C
Effective with the Dec 2020 expiry, New Orleans is no longer a delivery point and Dallas/Ft. Worth, TX becomes a delivery point.)
Basis Grade Quality: Strict Low Middling Staple Length: 1 2/32nd inc
First Day Notice Five business days before the first delivery day of the spot contract month, which is the first business day of that month.
Last Trading Day Seventeen business days from end of spot month.
Last Notice Day Twelve business days from end of spot month.
Trading Hours
Trading Pre-Open
NEW YORK: 9:00 PM-2:30 PM*
7:30 PM
LONDON: 2:00 AM-7:30 PM
12:30 AM
SINGAPORE: 9:00 PM-2:30 AM*
7:30 AM
* Next Day
Source: ICE

Cotton Facts

The four major cotton-producing countries are: China, India, the U.S., and Pakistan. The United States is responsible for one third of cotton that is traded and is the world’s leading exporter in this cash crop. Annually, the U.S. cotton industry profits around $25 billion, while providing over 200,000 jobs. U.S. cotton production is concentrated in the Southern U.S. as well as California. Depending on the climate, the cotton planting season can start as early as March, while the harvest can go well into December. The most popular type of cotton grown in the U.S. is called American Upland which accounts for 97% of all U.S. cotton crop grown every year.

Cotton #2 futures contracts are traded on the NYBOT while cotton futures contracts are traded on the NYMEX; both contracts have the same delivery dates.

Last updated May 2020

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Last Updated on August 16, 2020

4 Reasons You Might Invest in Cotton

Investors might want to consider the following reasons for investing in cotton:

  1. Bet on Global Stockpiling
  2. Bet on Strong Global Economy
  3. Bet on Inflation
  4. Bet on Higher Oil Prices

Betting on Global Stockpiling

China has shown a tremendous appetite for cotton and willingness in recent history to build up huge stockpiles. The country has taken these measures to support and subsidize Chinese farmers.

Chinese growth has stalled in recent years creating weakness in many commodity prices. The country has been selling its stockpiles, and this has offset the pickup in demand from Chinese consumers.

In addition, many other countries have diminishing stockpiles. If global growth accelerates, then some of these countries could resume stockpiling.

Is Cotton a Safe Haven?

Commodities such as cotton do well when global economies are growing at a healthy pace. In particular, emerging market countries with higher growth rates are likely to experience big increases in their demand for cotton clothing and cotton products as they grow wealthier.

How Does Cotton Act as an Inflation Hedge?

Investing in cotton and other commodities is a way to hedge against the loss of purchasing power caused by inflation.

As central banks print more money, the purchasing power of fiat currencies (i.e., the dollar, euro and pound) declines. However, there is a finite amount of natural resources, so agricultural commodities such as cotton are more likely to retain their value.

Speculating on Oil Prices

The high correlation of cotton prices with crude oil makes investing in cotton an interesting way to capitalize on a rise in crude prices. Since crude is both an important ingredient in polyester production as well as a cost of cotton farming, cotton may benefit more than crude oil if prices for crude oil move higher.

Crude Oil Prices Affect Cotton Farming and Polyester Production – Image via Pixabay

Should I Invest in Cotton?

As with many other commodities, cotton prices can be very volatile.

However, investing in cotton can be one way to mitigate risk and diversify the investments in a portfolio.

Investors should consider the advantages of investing in a basket of commodities that includes cotton, other agricultural commodities, metals and energy:

  1. Protection against inflation.
  2. Protection against price swings in individual commodities.

Including cotton in this basket may be a way to capitalize on these developments:

  1. Global Growth: China and India are enormous countries with fast-growing economies. These and other emerging market countries will have huge needs for raw materials such as cotton in the years ahead.
  2. Climate Change: Global warming has the potential to create supply shocks in the years ahead. Prolonged periods of drought might create diminished crop yields and higher prices.

However, traders should also consider the risks of investing in cotton:

  1. Sales of Chinese stockpiles of cotton could create a serious overhang on the market.
  2. A fall in price or increase in production of competing materials such as polyester could drive demand away from cotton.
  3. Subsidies of cotton in many countries could lead to overproduction and trade wars.

What Do the Experts Think About Cotton?

Experts see the excess supply of cotton as a major headwind for the commodity’s price.They note increased production as the main catalysts for lower prices:

The supply side should remain ample, and if we see production ramp up, cotton will see further losses.

– Lara Magnusen, portfolio manager, Altegris Advisors LLC

Other experts note the sale of China’s stockpiles as a negative market factor:

People used to say that because so much of the world inventory was within China, that it was bullish, because it was never going to come out. Now, we are in the reverse situation.

– Gillian Rutherford, commodities portfolio manager, Pacific Investment Management Co.

However, one analyst believes the pollution caused by polyester manufacturing could provide a glimmer of hope for cotton prices in the years ahead:

China has now forced the closure of numerous polyester manufacturing facilities due to widespread pollution. Increasing cotton’s share of the fiber market will be difficult at best, but as mills and textile operations understand that cotton is the only sustainable fiber being produced then that growth will come.

– O.A. Cleveland, Consulting Economist, Cotton Experts

How Can I Invest in Cotton?

Investors have several ways to invest in cotton:

Cotton Trading Methods Compared

Leverage? Regulated Exchange? Cotton Futures 5 N N Y N Y Y Cotton Options 5 N N Y N Y Y Cotton ETFs (ETNs) 2 N N N Y N Y Cotton Shares 2 N N N N Y Y Cotton CFDs 3 N N N N Y Y

Cotton Futures

The New York Mercantile Exchange (NYMEX), which is part of the Chicago Mercantile Exchange (CME), and the Intercontinental Exchange (ICE) offer a contract on cotton that settles into 50,000 pounds of the commodity.

Both contracts are traded electronically and have expiration months of March, May, July, October and December.

Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. At expiration, the contracts are financially settled on the NYMEX, but physically settled on the ICE.

Cotton Options on Futures

Options are also a derivative instrument that employ leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.

Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of cotton futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in cotton futures to profit from their trades.

Cotton ETFs

These financial instruments trade as shares on exchanges in the same way that stocks do. Two ETFs invest in cotton through futures markets:

Top 2 Cotton ETFs

Shares of Cotton Companies

There are no public companies that are pure-play investments in cotton. However, traders that want some indirect exposure to cotton prices can purchase shares of companies that provide products and services to farmers:

iPath Bloomberg Cotton Subindex Total Return ETN iPath Pure Beta Cotton ETN
Company Current Price Description Exchange Founded Employees Interesting Fact
Global agricultural company that provides seeds, genomic and other products to farmers. New York (NYSE) 1901 20,500 In 1983, Monsanto was one of four organizations who introduced genes to plants. The Mosaic Company Global agricultural company that sells crop nutrients to farmers. New York (NYSE) 2004 8,000 Mosaic is the United States’ largest producer of phosphate fertilizer and potash. Origin Agritech Ltd. Agricultural biotechnology company that sells hybrid crop seeds in China. New York (NASDAQ) 1997 400 Origin Agritech is the leading agricultural biotechnology company in China.

One way to invest in cotton is through the use of a contract for difference (CFD) derivative instrument. CFDs allow traders to speculate on the price of cotton. The value of a CFD is the difference between the price of cotton at the time of purchase and its current price.

www.plus500.com (76.4% of retail CFD accounts lose money).

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“76.4% of retail CFD accounts lose money

Many regulated brokers worldwide offer CFDs on cotton. Customers deposit funds with the broker, which serve as margin. The advantage of CFDs is that traders can have exposure to cotton prices without having to purchase shares, ETFs, futures or options.

One of the leading CFD brokers for trading agricultural commodities, like cotton, is Plus 500. Here’s why:

  • No commission on trades (other charges may apply)
  • Free demo account
  • Easy to use (mobile-friendly) platform
  • Industry-leading risk management tools
  • Trade cotton and hundreds of other markets
  • Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission

Start Trading at Plus500.com 76.4% of retail CFD accounts lose money.

One of the leading CFD brokers for trading agricultural commodity CFDs, like cotton, is Plus 500. Here’s why:

  • No commission on trades (other charges may apply)
  • Free demo account
  • Easy to use (mobile-friendly) platform
  • Industry-leading risk management tools
  • Trade cotton and hundreds of other CFDs
  • Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission

Important: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail trader accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

The use of New York cotton futures contracts to hedge cotton price risk in developing countries



Suggested Citation

Download full text from publisher

References listed on IDEAS

  1. Gemmill, Gordon, 1985. ” Optimal hedging on futures markets for commodity-exporting nations ,” European Economic Review, Elsevier, vol. 27(2), pages 243-261, March.
  2. Rolfo, Jacques, 1980. ” Optimal Hedging under Price and Quantity Uncertainty: The Case of a Cocoa Producer ,” Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 100-116, February.
  3. Satyanarayan, Sudhakar & Thigpen, Elton & Varangis, Panos & DEC, 1993. ” Hedging cotton price risk in Francophone African countries ,” Policy Research Working Paper Series 1233, The World Bank.
  4. Larson, Donald F., 1993. ” Policies for coping with price uncertainty for Mexican maize : policies for maize price variability in Mexico ,” Policy Research Working Paper Series 1120, The World Bank.
  5. Varangis, Panos & Thigpen, Elton & Takamasa Akiyama, 1993. ” Risk management prospects for Egyptian cotton ,” Policy Research Working Paper Series 1077, The World Bank.

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