Here's Why I'm Bearish On Cotton

Since establishing a bottom on 11/22, cotton prices have appreciated 14% trading Tuesday to their highest level since 8/20. While past performance is not indicative of future results you can clearly see a pattern on the chart below that prices in the high 80's appears to be unsustainable. I am operating under the influence that futures are very close to finding an inflection point and I see prices in the low-to-mid 80's in the coming weeks.

Bearish Trade Make Sense
In 2013 China was big buyer of cotton building up their domestic reserves. China recently announced in 2014 that it will scrap the controversial scheme to stockpile the commodity and will instead try direct subsidies for farmers. The key is not that they're subsidising farmers but how much they ultimately give. I think that cotton may come under pressure from the change as it could free up more locally grown cotton, denting China's demand for imported fiber. Hence a lack of demand for US cotton. In recent years in Ag, energies and metals, China's voracious appetite for commodities -- or lack thereof -- has been an influence on underlying prices. That in combination with a technically overbought market and preliminary signs of exhaustion are the reasons I feel bearish trade make sense at this juncture.


Trade Ideas
Though I show a chart of March futures, which is the current front month and where most of the action is, I'd prefer for an options trade to have a little more time, so I've opted to trade May contracts with clients.

Buy (1) in the money 90 put while simultaneously selling multiple (2 or 3) May 81 puts. I am looking to hold for the next 30-60 days and expect prices to grind lower. My 90 leg should be intrinsic and I am looking to capture 70-70 of the move based on the current delta. I am also looking for theta decay as ultimately I expect support to be found 82-84 cents so my other leg sold should not go intrinsic. Today clients paid $900 in premium per strategy.

If held until expiration, this trade makes money with futures under 88.2. If we see prices move violently lower we will need to manage the trade and make adjustments...stay tuned.