Lubbock, Texas
March 26, 2003

by Tim W. McAlavy, t-mcalavy@tamu.edu

Growers concerned about how planting intentions may affect the bullish cotton market should consider putting a floor under their cotton cash price, said a Texas Cooperative Extension economist. USDA projections for domestic carryover stocks have declined in the past two years, and the world ending stocks-to-use ratio has finally fallen below 40 percent for the first time since 1995. These conditions
make the cotton market more bullish than it has been in a some time, said Jackie Smith, Extension economist based at Texas A&M's Agricultural Research and Extension Center at Lubbock.

"The ‘A' index, which is considered the ‘world' cotton price, currently exceeds 60 cents per pound – the highest it's been in two years. Higher new-crop futures prices since October 2002 reflect that price optimism," Smith said. "When the December 2003 futures contract trades above 60 cents, we are concerned that next year's counter cyclical price (CCP) may be reduced by a national average price that exceeds 52 cents per pound." "A lower CCP should weigh in your financial decisions. You may want to consider hedging that CCP. Adding to the confusion is the prospect of higher planting intentions (more cotton acres) and the potential for larger-than-expected cotton crop this year."

Hedging is one way to protect your cash price when higher-than-expected planting intentions threaten to drive new-crop futures prices lower. Even so, many producers seem to have little interest in hedging to protect their cash price, Smith noted.

"Many of these growers may not completely understand the marketing loan program. The program has been with us for at least three farm bills, but the loan rate provided by this program does not guarantee your cash price," Smith said. "The marketing loan is designed to help producers achieve a total cash price, plus other program benefits that total close to the loan rate for your lint quality."

"For example, the South Plains November cash price for base loan quality cotton will usually be six to seven cents below December futures. During the last two years, the marketing loan program has resulted in a total price near the loan, but not with just the cash price."

In November 2001, cash prices were at or below 30 cents per pound and the loan deficiency payment (LDP) was almost 20 cents – which gave producers roughly the loan price. In November 2002, the same thing occurred except cash prices were just over 40 cents and the LDP was around 10 cents, Smith noted. "During both of the last two years, we could have set a floor of about 40 cents on our cash price and earned an extra 10 cents on our 2001/2002 crop. Producers who enhance their price through hedging get the same market loan benefits, but they also achieve a higher total price that can
boost their profitability," the economist said.

In the current market, producers could employ a simple strategy of using put options to set a floor cash price of about 50 cents net of premium and expected basis. In other words, a 59 put at 2.5-cent premium and an average basis of -6.5 cents.

"There are other pricing strategies that would work, too – such as window or option spreads," Smith said. "But the simple strategy of using put options to set a floor cash price is especially relevant for producers who plant cotton when conditions favor a potentially large crop that could severely reduce market prices."

Smith and Carl Anderson, another Extension economist, will teach a workshop on evaluating and implementing pricing alternatives on April 10-11, at the Lubbock center. They will discuss marketing plans and risk management tools that apply to cash prices and the CCP.

The workshop runs from 9 a.m. to 4 p.m. both days, and costs $150 per person. The registration fee includes all course materials and lunch. You can register for the workshop by calling Smith at (806) 746-6101, or by visiting your local county Extension office to obtain a registration form.